No growing pains, but RBA stays reserved

The Reserve Bank has slightly hedged its bets in its latest quarterly statement on monetary policy. One question for sharemarket investors is whether they should do the same.

In the quarterly monetary policy review on Friday, the central bank maintained its estimate that the Australian economy would grow by 2.5 per cent in the current year to June, but knocked its forecasts for the economic growth in calendar 2014 and the year to June 2015 down by half a percentage point, to between 2 per cent and 3 per cent and between 2.25 per cent and 3.25 respectively.

It also predicted stronger growth of between 2.75 per cent and 4.25 per cent in the 2015 calendar year, but is being more cautious about how efficiently Australia's non-resources economy fills the hole a retreating resources investment boom creates.

It believes the resources retreat will be faster than it expected when it wrote its August monetary policy statement, particularly in 2014-15. There will be delays in coal mining expansion in particular, but also in iron ore and liquefied natural gas investment, it says, and Australian Bureau of Statistics data on resources sector investment expectations is "inconsistent with the lack of new commitments to mining projects and a lack of current expenditure on development and planning work that would precede new projects."

It also says that non-mining investment is subdued and likely to stay that way for a year. That problem is combining with others, including relatively tight government and consumer spending to hobble the non-resources sector's expansion as resources investment decreases, and the stubborn strength of the currency is a factor.

The Reserve assumes a constant exchange rate in the forecasts it published in its quarterly statements on monetary policy. When it left its cash rate unchanged at 2.5 per cent last Tuesday it said, however, that the $A was "uncomfortably high," and its latest monetary policy statement links the $A to the growth forecast downgrade, stating the strength of the currency will "constrain activity in the traded sector by more than was expected three months ago."

Now let's take a look at the sharemarket. Between the Reserve's August statement on monetary policy and the one it released on Friday, the S&P/ASX 200 Index has risen by 6.7 per cent to be almost 23 per cent up for 2013. Wall Street's Standard & Poor's index of 500 leading US listed companies has risen by 3 per cent, to be up just under 25 per cent for the year.

The rally has basically been driven by global forces: in no particular order, evidence that America's economy is getting back on a growth track that can amortise its debt overhang, easing concerns about Europe's outlook, signs that China's growth rate has stabilised about 7.5 per cent, and the rise in "animal spirits" that accompanies such news, and what it says about the odds of another global meltdown and the risk premiums that investors require when they take on exposure to shares.

Regardless of why it has risen, the sharemarkets are no longer the screaming bargain that they were, however.

Evans & Partners chief strategist Mike Hawkins noted this week that investors looking for anecdotal signals that the rally was in a "late-cycle" phase now have close to a full hand. They were paying more for a given amount of earnings, takeovers and company floats were on the rise and risk premiums were falling, all "classic signals", he said, adding: "All that is missing is rising interest rates. Led by the US, this final signal will emerge in 2014. It can only not emerge if something bad happens."

The companies that make up the ASX 200 index posted combined earnings of $321 a share in the year to June 30. They are expected to boost earnings by just under 8 per cent to $346 a share in the current year to June, but that has been overwhelmed by the increase in their collective share price - the rise in the value of the index itself - and shares are accordingly more expensive as an asset class.

At the end of June, the ASX 200 could be acquired at share prices that equated to a multiple of 13.3 times their expected earnings in the next year, well up on a multiple of 10.8 times at the end of June 2012. Today they cost 14.7 times expected earnings. The average over the past decade, a period that embraces the global crisis and the sharemarket boom that helped seed it, is about 13.5 times. Australian industrial shares have also risen, from 14.8 times expected earnings a year ago to 17 times now, above a 10-year average of 15.7 times.

Wall Street shares have moved in the same direction. The S&P 500 index has risen from 12.3 times expected earnings at June 30 last year to 13.9 times expected earnings at June 30 this year, and 14.6 times expected earnings now. Its 10-year average multiple is about 14.2 times.

My conclusion is that if profits are available, particularly ones that help restore the original dollar diversity of your share portfolio, you might consider taking a few of them.

Don't sell out. The back story to this rally is a global economic recovery that further reduces crisis event risk. Share prices are capable of rising further from here.

Picking the absolute top is a high-risk game as tighter US monetary policy looms, however, and index peaks are now not far away, at 16.2 times expected earnings for the ASX 200, 18.9 times for the ASX industrials and 16.2 times for Wall Street's S&P 500 index. Those valuations were struck in 2007, and as we now know, they were unsustainable.

mmaiden@fairfaxmedia.com.au