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

Buy the dips?

Amid a tornado of headlines, where can investors find opportunity?

Cyclical stocks will drive markets higher in 2025

banner

Most viewed in recent weeks

Raising the GST to 15%

Treasurer Jim Chalmers aims to tackle tax reform but faces challenges. Previous reviews struggled due to political sensitivities, highlighting the need for comprehensive and politically feasible change.

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

100 Aussies: seven charts on who earns, pays, and owns

The Labor government is talking up tax reform to lift Australia’s ailing economic growth. Before any changes are made, it’s important to know who pays tax, who owns assets, and how much people have in their super for retirement.

9 winning investment strategies

There are many ways to invest in stocks, but some strategies are more effective than others. Here are nine tried and tested investment approaches - choosing one of these can improve your chances of reaching your financial goals.

The rubbery numbers behind super tax concessions

In selling the super tax, Labor has repeated Treasury claims of there being $50 billion in super tax concessions annually, mostly flowing to high-income earners. This figure is vastly overstated.

With markets near record highs, here's what you should do with your portfolio

Markets have weathered geopolitical turmoil, hitting near record highs. Investors face tough decisions on valuations, asset concentration, and strategic portfolio rebalancing for risk control and future returns.

Latest Updates

Investment strategies

Finding income in an income-starved world

With term deposit rates falling, bonds holding up but with risks attached, and stocks yielding comparatively paltry sums, finding decent income is becoming harder. Here’s a guide to the best places to hunt for yield.

Economy

Fearful politicians put finances at risk

A tearful Treasury chief, a backbench rebellion, and crashing bonds. What just happened in the UK and why could Australia’s NDIS be headed for the same brutal fiscal reality?

Shares

Investing at market peaks: The surprising truth

Many investors are hesitant to buy into a market that feels like it’s already climbed too far, too fast. But what does nearly a century of market history suggest about investing at peaks?

Shares

Chinese steel - building a Sydney Harbour Bridge every 10 minutes

China's steel production, equivalent to building one Sydney Harbour Bridge every 10 minutes, has driven Australia's economic growth. With China's slowdown, what does this mean for Australia's economy and investments?

Investment strategies

Will stablecoins change the way we pay for things?

Stablecoins have been hyped as a gamechanger for the payments industry. But while they could find success in certain niches, a broader upheaval of Visa and Mastercard's payments dominance looks unlikely.

Infrastructure

An investing theme you can bet on for the next 30 years

Investors view infrastructure as a defensive asset class rather than one with compelling growth prospects. These five tailwinds for demand over the coming decades suggest that such a stance could be mistaken.

Investment strategies

A letter to my younger self: investing through today's chaos

We are trading through one of history's most confounding market environments. One day, financial headlines warn of doomsday scenarios. The next, they celebrate a new golden age. How can investors keep a clear head?

Sponsors

Alliances

© 2025 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.