Australia’s share market has been on a tear over the past 12 months, lifting by 27.9 per cent from the lows hit in late December 2018. This year alone, the benchmark S&P/ASX 200 has already gained 3.5 per cent, hitting fresh record highs earlier today.
However, Morgan Stanley’s Australian equities strategy team doesn’t expect the pace of gains to be sustained. When it comes to price to earnings (PE) multiples, it’s concerned that too much of the rally has been fuelled by the ‘P’ rather than the ‘E’, something it expects will make it difficult for the market to push much higher in the absence of improved earnings.
“Low rates and bond yields globally certainly boosted equity valuations and in Australia led to extremely stretched levels,” the investment bank wrote. “The ASX 200 finished the year at 17.3 times (forward PE), while Industrials ex-Financials finished at 24.3 times – close to 3 standard deviations above its long-run average.”
While those valuations reflect the impact of lower risk-free rates (government bond yields), making relative valuations appear less stretched, unlike the mindset of the broader market, Morgan Stanley is not chomping at the bit to buy at current levels.
“We retain our view that without a turn in the earnings cycle, current valuations will be hard to sustain and believe this supports our view of muted capital returns for 2020,” it said.