ASX prices keep rising in zero-gravity environment, thanks to the RBA

Every rate cut from a dovish Reserve Bank of Australia pushes price-to-earnings (PE) ratios further up by nearly 0.1 points a month, according to research by Mr Stoltz. The RBA has been in rate cutting mode since October 2011, or for the past 100 months.

The PE ratio aggregate for the industrials sector (excluding financial companies) has shot up to 29.4 times earnings, up from 17.5 times in December 2018. It is now at the highest rate since the 1930s.

Prices for tech stocks are at 113.8 times earnings and prices for health care shares are at 36.2 times. Utilities and general industrial stocks have lower ratios at 15.4 times and 16.9 times, respectively.

We don’t really have a good benchmark for how this is going to play out.

UBS analyst Pieter Stoltz

The UBS team estimates that since 2009 only about 5 per cent of returns from investing in the ASX were due to rising company profits. Most of the gains came from rising stock prices and increasing dividends. In contrast, before the financial crisis about 45 per cent of returns were thanks to companies’ profit growth.

The analysts expect earnings per share growth of 3 per cent in 2019-20, compared to a 30-year average of 4.5 per cent.


Price-to-earnings ratios have not been this high since 1999, Mr Stoltz said. Despite this, today’s markets aren’t partying like it’s 1999: They are behaving differently from 20 years ago when the ”euphoria of the tech bubble” was driving up prices.

The RBA held interest rates at 4.75 per cent during 1999, raising them to 5 per cent at the end of the year. Now the official cash rate is 0.75 per cent and could drop further by the end of the year.

Interest rates ”act like gravity” on equity valuations, Mr Stoltz said, citing US investor billionaire Warren Buffet. Without that gravity, everything is rising.

“We don’t really have a good benchmark for how this is going to play out,” he said. “But providing earnings growth rates don’t fall off a cliff and you are selective about which sectors you allocate into, you could still receive a decent return from equities.”

Emma Fisher, a portfolio manager at the $8.2 billion Airlie Funds Management, said earnings multiples on Australian stocks might look stretched, but dividend yields look reasonable when ”compared to the dearth of returns in basically every other asset class, including cash”.

Returns from stocks are good, if compared to the ”dearth” of returns from other assets, says Airlie Funds Management’s Emma Fisher. Credit:Sam Mooy

“It doesn’t change how we pick stocks, but it does make opportunities thinner on the ground,” she said.

“We look for businesses with good prospects, management teams, balance sheets and valuations. The last part of the equation is getting increasingly difficult, though not impossible, to find.”

Investors should “be selective about where you put your money when the valuations of companies with pretty average prospects have been bid up across the board,” she warned.

Stock prices are now hypersensitive to changes in central bank policy. Prices might hold when interest rates start rising again – but only if company earnings are growing, too, Mr Stoltz said.

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