PULLING Greece and Europe's banks back from the brink has put a base under the new-year sharemarket rally, and the US Federal Reserve is laying foundations now, too. Yesterday's 1.7 per cent Wall Street bounce and the buying around the world that accompanied it came after upbeat comments from the Fed about the US economy, and the release of a stress test for the biggest US banks that was not a perfect "10", but good enough to show that America's banking system is substantially repaired, and getting stronger.
There are two questions now. Is this finally the early stages of a convincing climb away from the global crisis and the collateral damage it caused? And if it is, to what extent can the Australian market participate?
The answer to the first question is there's not much unbought slack in global share prices given the rally that's already occurred. More good news is probably needed to push prices substantially higher. The answer to the second question is that Australia is handicapped something its base valuation reveals.
Yesterday's 218-point rise for the Dow Jones Industrial Average of 30 blue-chip stocks more than compensated for last week's losses including a 203-point fall on Tuesday, March 6, and took the market to levels last seen in late 2007, before the global crisis was fully deployed. The Dow average is also now just 7 per cent below the high it set in October 1997 in a brief, stupid rally out of its initial crisis downturn.
The US market is now trading at about 12.9 times expected corporate earnings for the next 12 months. That's well below the fair-value benchmark of about 15 times expected earnings that existed before the global crisis, but the relevance of that comparison is questionable. We are in a world that is growing more slowly and will be for years. Earnings multiples need to be lower to reflect that and it is quite possible that 13 times earnings is close to correct weight.
It's also worth noting that the market mood today and current overseas sharemarket valuations are strikingly similar to what they were in the first half of last year. The first Greek bailout had occurred by then, and the cautious consensus, returned now, was that Europe's sovereign debt crisis was not over, but being brought under control. US economic growth also appeared to be consolidating, as it does again now, and investors were pricing US shares at about 13 times expected earnings, as they are today.
The story is similar for the global sharemarket. The MSCI global sharemarket index was priced at an average of 12.2 times expected earnings in the first half of last year, and it is priced at 12.2 times expected earnings now.
The Australian market is different, however, and not in encouraging ways. The Australian portion of the MSCI global index, our top 100 stocks basically, is priced at about 11.3 times expected earnings in the next 12 months, down from an average of 12 times in the first half of last year. The multiple would be even lower now if analysts had not downgraded the outlook for earnings and the discount is evident in substantial underperformance. The S&P/ASX 200 Index is still only 10.9 per cent above the low it set on September 26 last year as Europe's sovereign debt crisis reignited. Wall Street's Dow average has risen 23.7 per cent since October 3, and the MSCI world index is up 21.8 per cent.
Can Australia catch up? Perhaps not for a while. All the markets remain sensitive to bad news, but economic growth is also cycling down here.
Commodity prices are still strong, but they are softening as China's economy slows, and the Reserve Bank is continuing to pummel our industrial and service sectors with an interest rate policy that aims at containing inflation in the resource sector, and encouraging the redirection of finite resources of capital, goods and labour to the boom.
High interest rates have driven the Australian dollar to a point where it is an unprecedented weight on export competitiveness outside the resource sector, a carbon tax that is pitched at twice the depressed international market price is just around the corner, the states are not spending to boost overall demand, and the federal budget in May will be sharply contractionary, assuming Labor maintains its target of a surplus next year.
The opposition, meanwhile, is making the same budget surplus promise, joining the Greens to block a tax cut for large companies because it's linked to Labor's mining tax, and threatening to impose a 1.5 per cent tax on the same companies to fund its parental leave plan.
You really couldn't make some of this stuff up, and announcements like Julia Gillard's creation of a small business commissioner yesterday or her elevation of the small business portfolio to cabinet are not going to change the market's mindset.
The overseas markets will continue to be defensively priced against expected earnings to reflect continuing risks in Europe's sovereign debt rehabilitation program and the US economic recovery. Share prices could still rise, however, if corporate profits exceed expectations in the March and June quarters.
If that happens, shares here would probably trend upwards, too. But they would struggle to match the overseas pace and on the current local settings are unlikely to close the gap that has opened up since the rally began. Local investors aren't facing something as concussive as a perfect market storm. But they are in a subtropical depression: a trough of policy-driven low pressure that brings with it profit-dampening rain, and a soggy sharemarket.
mmaiden@theage.com.au
Frequently Asked Questions about this Article…
What triggered the recent global sharemarket rally and should everyday investors be confident?
The rally followed upbeat comments from the US Federal Reserve about the US economy, a strong Wall Street bounce and a reassuring stress test showing America's big banks are substantially repaired. While this bought markets a base, the article notes there's not much unbought slack left in share prices, so more good news will likely be needed to push prices substantially higher. Everyday investors should be cautiously optimistic but recognise markets remain sensitive to bad news.
Are US banks safe now after the stress tests and how did that affect markets?
The stress test results weren’t perfect, but they were ‘good enough’ to indicate the US banking system is substantially repaired and getting stronger. That reassurance helped drive a Wall Street rebound and buying around the world, improving investor sentiment.
How do current US and global sharemarket valuations compare to historical levels?
The US market was trading at about 12.9 times expected earnings for the next 12 months, below the pre‑crisis fair‑value benchmark near 15 times. The MSCI global index sat around 12.2 times expected earnings—similar to levels seen in the first half of last year. The article suggests lower multiples may be appropriate in a slower‑growth world, so 13 times could be close to fair value today.
Why is the Australian sharemarket underperforming relative to the US and global markets?
Australia is trading cheaper—roughly 11.3 times expected earnings for the top 100 stocks—and has underperformed because local economic growth is cycling down, commodity prices are softening with China’s slowdown, the Reserve Bank’s high interest rates have weighed on non‑resource sectors, and a strong Australian dollar is reducing export competitiveness. Political and fiscal policy settings (a likely contractionary federal budget and tax changes) also act as a drag.
Can the Australian market catch up to overseas gains and what would drive that?
It’s possible but unlikely to match the pace of overseas gains in the short term under current local settings. The article says Australian shares would probably trend upwards if corporate profits exceed expectations in the March and June quarters, but they would struggle to close the gap unless local economic and policy conditions improve.
How do interest rates and the Australian dollar affect Australian exporters and investors?
High interest rates have supported the Australian dollar and acted as an unprecedented weight on export competitiveness outside the resource sector. That reduces export revenue prospects for many companies, dampens profits, and contributes to a soggier sharemarket—important factors everyday investors should watch when assessing Australian export‑exposed stocks.
What should everyday investors watch for in the near term to assess market direction?
Monitor corporate profit reports for the March and June quarters—better‑than‑expected profits could push share prices higher. Also watch developments in Europe’s sovereign debt situation, US economic signals from the Fed, commodity prices (especially with China slowing) and Australian policy moves such as the federal budget and any major tax changes, since all of these influence market sentiment and valuations.
How should investors interpret earnings multiples in today’s slower‑growth environment?
Earnings multiples are lower now because the world is expected to grow more slowly for some time. The article suggests that multiples that looked normal before the global crisis (around 15x) may no longer be appropriate, and current levels—around 12–13x in many markets—could be closer to fair value given slower growth expectations. For investors, that means valuations should be viewed in the context of longer‑term growth prospects, not just historical benchmarks.
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