Quick Bites | ASX Valuations Somewhat Rich

While markets have a habit of trending in one or another direction for extended periods, disciplined fund managers pay close attention to fundamental valuations to guide their decision-making. Global markets have been trending higher since October 2022, driven by the peaking of inflation, hopes for cuts in official interest rates, and surprisingly resilient economic growth. Equity market valuations are becoming stretched in terms of fundamental valuations, which means that prudent investors should use this time of strength in markets to re-examine the appropriateness of their asset allocations.

Where are valuations sitting on the ASX? 

According to highly regarded strategist Martin Crabb of SHAW and Partners, the market valuation at the moment (he looks at the S&P/ASX 100 index) is “hardly compelling”. He sees the expected total shareholder return as being only 4.93% (comprising 3.73% dividend yield and 1.20% capital gain) over the next 12 months. 

Source: SHAW and Partners

Martin’s model shows the price-to-earnings (PE) of the market as being one standard deviation expensive at 16.6x, with forward earnings only expected to grow 1% over the next year.

Source: SHAW and Partners

The key issue for ASX valuations is the absence of strong forecast growth in earnings, but of course, forecasts can be wrong, and a surge in commodity prices would have an outsized effect on the outlook for one of our major sectors. But, as Martin says, “In aggregate, ASX 100 company profits are expected to go nowhere”.

Source: SHAW and Partners

Source: SHAW and Partners

These observations should not discourage investors from remaining in equity markets, for the following reasons:

  1. Active fund managers select individual companies with better-than-average prospects, and so are not limited by the movement in the index.
  2. While the outlook for earnings growth in the next 12 months may not be great, serious investors are usually looking at a longer time frame.
  3. Most of us know that timing the market according to valuations is extremely difficult, and jumping in and out of equity markets often tends to be counter-productive.