MARKETS SPECTATOR: A price-earnings pickle

The market is trading above its 20-year average on a price-earnings basis, which has most analysts gloomy, but rate cuts may help it defy naysayers.

Not for the first time is the stock market baffling those who make their living off it.

The S&P/ASX 200 Index is now trading above its 20-year price-earnings ratio of 14.5 times forecast earnings, according to UBS equities strategist David Cassidy. He says the stock market has “detached” from fundamentals. Money is flowing into stocks because interest rates are low. The Reserve Bank's benchmark 2.75 per cent cash rate is a record low.

“I’d be a little bit reluctant to chase the market from here,” Cassidy says. “It’s not completely a free lunch.”

The Australian economy and company earnings are weak, he says. But “the party will probably go on for awhile” he adds.

Nomura’s Tim Rocks reckons the stock market party may come to an end sooner rather than later. He has not changed his year-end 4600 target for the S&P/ASX 200 Index. The Reserve Bank rate cuts are not having the desired impact on the economy, according to Rocks. By cutting the cash rate yesterday the bank has made a “capitulation” on its previous view the Australian economy was transiting successfully away from relying on the mining sector for growth, he says.

Moreover, the federal budget and tax concerns are going to have a greater effect on the economy and company spending patterns than whatever further cuts the central bank may decide to make, says Rocks.

Meanwhile, Rhett Kessler, at fund mangers Pangana, says business confidence is low.

“I’ve not found a business leader excited by the way business is travelling,” he says.

Official cash rate cuts are an attempt by the Australian central bank to dilute the strength of the Australian dollar and help business, according to Kessler. But he says there is a lack of confidence in government policy and execution, high labour costs and a fading mining boom.  

Still, others are not so gloomy with regard to the stock market.

Morgan Stanley Wealth Management’s Malcolm Wood has a year-end target for the S&P/ASX 200 of 5500. He predicts the Reserve Bank will cut the cash rate another 25 basis points. That will bring mortgage rates to GFC levels. Corporate profits will improve, according to Wood.

He expects, excluding mining companies, that earnings per share growth for companies in fiscal 2013 will be up 5 per cent year-on-year. In fiscal 2014 Wood forecasts 10 per cent EPS growth.

His recommendations include News Corp and ResMed. China’s economy will improve, according to Morgan Stanley. Wood recommends Rio Tinto shares. He also says Stockland, Land Lease, and Wesfarmers shares are a buy.

Individual investors are not slackening their thirst for equities, argues Wood. About $452 billion in additional Australian bank deposits have been made since August 2008. With term deposits set to fall below 4 per cent, more money will flow into the stock market, he says.

But Kessler warns it is harder to find “good businesses with competent managers at the right price”. Still, his fund has recently bought shares in Caltex and AMP.

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