Australian stocks are 'pricey' but they're not at a danger level yet

Photo by Mark Kolbe/Getty Images

Australia’s ASX 200 has jumped out of the gates this morning, continuing the bullish price action seen earlier this week.

From the low of 5,681 struck on March 22 — just one week ago — the index has surged over 3%, leaving it sitting this morning at the highest level since May 5, 2015.

The technical traders are licking their lips, eyeing a run towards the 6,000 point level should the index manage to close above its previous range high of 5,833.2 set in mid-February.

ASX 200 Daily Chart

It’s been a remarkable turnaround, but is being driven by fundamentals or quarter-end window dressing, just three days before the end of March.

The timing of this recent investor exuberance was not lost on David de Garis, director of economics at the National Australia Bank.

“Getting towards the end of the month and the end of the quarter, and given the torpor of risk assets markets of late, the return of some buying could easily have occurred,” he said. “That could well be part of the explanation for overnight move.”

The timing is slightly suspicious, but does the price action back up the fundamentals?

It’s something that Chris Weston, chief market strategist at IG Markets in Melbourne, has been looking at closely.

And his verdict? The ASX 200 is looking slightly pricey right now, but it has been higher in recent years.

“The ASX 200 is trading on 16.1 times forward earnings, which is 6% above the 5-year average of 15.2 times, but still below the 17 times forward multiple investors were paying in Q2 2015 and mid-2016,” he says.

“So the market is pricey, but not at a level where the fund managers really start getting hot under the collar, going to cash or looking at hedging structures. That comes when the index trades on a multiple of 17 times and into 17.5 times.”

While Weston thinks that from a valuation perspective things are slightly rich, he wonders what fundamental factors will be able to drive the market higher from here, particularly as valuations have been greatly assisted by upward revisions to earnings estimates, particularly in the energy and resources sector.

“Earnings per share (EPS) have been revised higher consistently since mid-2016 and now sit at 361 cents — a rise of around 20% in that time. But what is going to propel earnings higher from here is now the key question, given a lot of the EPS revisions have come from higher oil, bulks and base metals,” he asks.

“Global growth is looking a touch better, but Trumponomics is looking shaky and mostly a 2018 story. US corporate tax reform would be a positive for the S&P 500 — and specifically the Russell) — but I can’t see how it will be positive for Aussie earnings.”

Despite those doubts, he suggests the price action today could see the index push as high as 6,000 points in the period ahead.

However, should that eventuate, Weston thinks that could offer an opportunity for profit-taking.

“While the prospect of 6,000 is welcomed, I am sceptical the earnings side of the equation pushes higher from here and a move into 6,000 should see the ASX 200 pushing above 17 times — a level the market has shown they just aren’t comfortably paying for those future earnings and cash flows,” he says.

“All we need then is some macro concerns and we will be highly vulnerable to a much greater sell-off and shorting opportunities will be far more abundant.”

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