This analyst says the ASX200 is starting to feel gravity's force

RIO DE JANEIRO, BRAZIL – JANUARY 18: A teen dives off the rocks at Arpoador on January 18, 2015 in Rio de Janeiro, Brazil. U.S. government scientists reported that 2014 was the hottest year on record, with temperatures globally measuring 1.24F (0.69C) higher than the 20th-century average, (Photo by Mario Tama/Getty Images)

The ASX 200 fell 31.5 points yesterday, or 0.5%, to close at 5,769.

That’s not much of a pullback in the grand scheme of things, particularly given the ASX200 rallied from the mid 5200’s less than a month ago.

But Evan Lucas, IG Markets Equity Strategist, reckons the market is looking very overbought and ripe for a retracement.

In a note to clients Lucas wrote that the “ASX remains on a tear – even after the the small consolidation over the past two days.” He did add a strong note of caution for current pricing (as at 9am yesterday morning) saying that “there are some interesting market fundamentals in the current market that need to be taken into account”:

Here is his list. A warning though: it might make a few longs nervous.

  1. The material space has added 11% in the past three weeks, mostly due to the big miners. The kick here is the USD and the fact both RIO and BHP have a yield above the current ASX 200 net dividend yield.
  2. Since mid-January, the ASX has added over 9% in value and reached a six-year high of 5850.9.
  3. The ASX 200 net dividend yield has fallen to 4.5% compared to its historical average of 4.86% in this time – a full standard deviation away.
  4. Australian government bonds also fell to record lows and are reinforcing the flight to equities with bond-like characteristics.
  5. The January rise has seen the ASX now trading almost two standard deviations from its historical P/E average of 13.1 times. At 16.1 times earnings on a 12-month forward basis, there is no doubting the ASX is expensive.
    Source: IG Markets
  6. Perhaps more concerning about the P/E ratio is the fact earnings per share (EPS) growth in FY15 is forecasted to grow at a measly 2.1%. Finding discounted equities in the current market (without exposure to commodity risk) is rare, as the flattening of the yield curve is making bloated trades very toppy.
  7. Business conditions remain weak and the likelihood of further rate cuts is growing, as inflation and growth fall and unemployment starts to rise. EPS growth in the first part of FY16 will be just as benign, even with the rate cuts – consider the time it takes for these macro tools to filter into the actually economy.
  8. A near-term catalyst for a further move higher will remain the chase for yield. However, considering the bloated nature of this trade, the upside appears limited and any reversal in the bond market will see equities shed as investors jump back to the low-risk bond market.

Markets, even bull markets, don’t go up forever and Lucas is just reminding traders that gravity is a force as active in markets as it is in nature.

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