No, the Aussie market isn't a bubble. Here's proof.
The market's price-earnings ratio and dividend yield tell a different story to the news you're reading.
Type ‘Australia stock bubble 2018' into Google and you get just over a million results. The financial news is designed to excite investors – any reader will quickly find themselves drowning in the words ‘bubble' and ‘crash'.
Yet, I came across two charts this week that suggest the Aussie stock market is far from overvalued – in fact, it couldn't be more bland. At the time of writing, the S&P/ASX All Ordinaries Index had a price-earnings ratio of 15.8 and a dividend yield of 4.2%. Both measures are almost bang on their averages since 1980 of 15.1 and 4.1%.
If anything, it's surprising that these ratios aren't extraordinary because interest rates very much are – they're the lowest they've been since the 1960s.
None of this is to say that you should rush out to buy or sell stocks. These valuation metrics are useless when it comes to predicting what's going to happen next, which is why the analysts at Intelligent Investor prefer to spend their time researching individual companies and fundamentals, rather than try to time the market with ‘top-down' predictions.
It's natural that you want to stay up-to-date with what's happening in the market, but magic ratios like the ones above play on everyone's innate information bias – our tendency to believe that the more information we acquire, the better our decision will be, even if the additional information is irrelevant. This leads to overconfidence and risky behaviour, steering you towards a short-term mindset and unnecessary trading.
Ultimately, you should forget about trying to value the market. Your job as a value investor is to find individual stocks that adequately compensate you for their specific risks.
We first recommended members buy Sydney Airport (ASX: SYD) back in 2002 when it listed at $1.00, but upgraded the stock again in 2013, as part of our 'High yield and safe mini-portfolio', when it was trading at $3.18.
Had you been watching the All Ords' price-earnings ratio for guidance, you would have been horrified – we were buying the stock at the market's highest valuation in 10 years. Since then, however, members have more than doubled their money. Focusing on market ratios would've meant missing out on buying one of Australia's best businesses at a bargain price.
We can't time markets, but we do know that cash is a lousy investment over the long term and you're better off holding productive assets like stocks and property (see How much cash should you hold?).
If you're investing for the next 10 or 20 years, whether the market's price-earnings ratio is above or below average today probably doesn't matter that much. What does matter is what the current share prices of your holdings are relative to each company's intrinsic value. That's it. If you stick to buying high-quality companies when they're undervalued, you'll do well no matter where the market stands.
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