Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 253

Little room for error in equity markets now

The key reason for concern about exposure to equity markets is the over-pricing in much of the market in the US, Europe and UK. The US stock market makes up more than half of the global market capitalisation and what happens in the US echoes around the world.

We have been relatively bullish on US shares since the start of the current ‘Quantitative Easing’ and technology boom, especially stimulated by smart phones, since 2012. It has been a tremendous rally, with the US broad market returning an incredible 140% in the past five years led by tech giants Apple, Amazon, Facebook, Google, Microsoft, and the like. The problem is not profits or dividends as both have been rising strongly during the boom, and the current profit reporting season has seen more double-digit profit growth. The problem is that everybody has come to expect double digit profit growth as the norm, but it is not sustainable and never has been.

Downside risk now dominates

Prices are so high and profit growth so strong that there is now little room for error. We are at a point where there is more downside than upside. The chance of share prices doubling in the next year or so is small, but share prices could easily fall dramatically and languish for years – as they have done several times in the past.

The chart below shows the broad US stock market index in real (inflation-adjusted) terms (blue line) since 1900. The green line shows aggregate annual company earnings (profit) per share across the market. Profits oscillate up and down wildly through booms and busts. The maroon line is the 10-year average real earnings per share. This is much smoother.

Real profit growth (maroon line) has averaged just 2% per year for the past couple of centuries. In that time, America has grown from being an ‘emerging market’ to the largest economy in the world in which its leading companies dominate most industries on the planet. Even in recent decades, real profit growth has still averaged around the same 2% per year.

Click to enlarge

Watch for complacency

Company profits (green line) rise strongly in booms as they are doing now. The problem is that whenever the green profit line rises too far above the maroon trend line as the booms progress, people become complacent and set their expectations too high. They expect double-digit growth to last forever. Whenever boom-time profits reach beyond about 30% above the long-term trend, share prices tend to snap back sharply in sell-offs. The last big sell-off was the 2008-2009 ‘GFC’.

The profit line is currently 30% above its long-term trend and that is on a par with numerous prior booms before sell-offs. So we are in dangerous territory. A further concern is that the current market expectations of profits for the next couple of years (red line on the far-right end of the green profit line) is for further astronomic profit growth, heading into the stratosphere.

For the current tech boom to continue at the same pace as it has been to date, Apple, Amazon, Facebook, Google, Microsoft, etc would need find a new planet, fill it with another 7 billion people and then sell phones, apps and software to them all within the next few years! Elon Musk at Tesla is doing his best, but it will not be quick enough.

 

Ashley Owen is Chief Investment Officer at advisory firm Stanford Brown and The Lunar Group. He is also a Director of Third Link Investment Managers, a fund that supports Australian charities. This article is general information that does not consider the circumstances of any individual.

 

RELATED ARTICLES

US will fall more than Australia in next bust

banner

Most viewed in recent weeks

16 ASX stocks to buy and hold forever

In his recent shareholder letter, Warren Buffett mentions several stocks he expects Berkshire Hathaway will own indefinitely, including Occidental Petroleum. We look at ASX stocks that investors could buy and hold forever.

The best strategy to build income for life

Owning quality, dividend-producing industrial shares is key to building a decent income stream. Here is an update on the long-term performance of industrial stocks against indices, listed property, and term deposits.

Are more taxes on super on the cards?

The Government's broken promise on tax cuts has prompted speculation about other promises that it may consider breaking. It's widely believed that super is lightly taxed and a prime candidate for special attention.

Lessons from the battery metals bust

The crash in lithium and nickel prices has left companies scrambling to cut production, billionaires red-faced, and investors wondering how a ‘sure thing’ went so wrong. There are plenty of lessons for everyone.

Welcome to Firstlinks Edition 545 with weekend update

It’s troubling that practical skills like investing aren’t taught at schools as it leaves our children ill-equipped to build wealth, and more vulnerable to bad advice. Here are some suggestions to address the issue.

  • 1 February 2024

For the younger generation, we need to get real on tax

The distortions in our tax system have been ignored for too long, and we're now paying the price. It's time Australia got real and addressed the problems to prevent an even greater intergenerational tragedy.

Latest Updates

Shares

16 ASX stocks to buy and hold forever

In his recent shareholder letter, Warren Buffett mentions several stocks he expects Berkshire Hathaway will own indefinitely, including Occidental Petroleum. We look at ASX stocks that investors could buy and hold forever.

Investment strategies

Clime time: 10 charts on the outlook for major asset classes

The charts reveal that interest rates can't rise much further as Australian mortgage holders are under stress, bank dividends look solid, and the bond market is in flux because yields are being manipulated.

Strategy

Phasing out cheques, and what will happen to cash?

Cheques and bank service, or the lack of, were major topics when I addressed a seniors’ group recently. The word had got out that the government was phasing out cheques, and many in the audience were feeling abandoned.

Retirement

What financial risks do retirees face?

Treasury's consultation into the retirement phase of superannuation is generating a lot of interest. This submission to the consultation outlines the key financial risks to an individual’s standard of living in retirement.

Shares

Recession surprise may be in store for the US stock market

Markets are partying like it's 1999, but history suggests that US earnings and economic growth are vulnerable following an interest rate tightening cycle. Investors should prepare their portfolios accordingly.

Investment strategies

3 under the radar investment opportunities

The Magnificent Seven are hogging the headlines, yet there are plenty of growth opportunities elsewhere, at a fraction of the cost. Here are three stock ideas riding key areas of structural and cyclical change.

Shares

Why a quant approach can thrive in the age of passive investing

The rise of passive investing is unlikely to derail the value of quantitative strategies. Passive investing hasn’t eradicated the irrationality of crowds, leaving pockets of opportunity to outperform indices.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.