This article is from the Australian Property Journal archive
The recent surge in Australian shares is not comparable to the surge in US shares during the tech boom or the 1987 share bubble. Share price gains and valuations have been far more reasonable this time around.
The run of strong gains in the Australian share market over the last few years has led to comparisons with the tech boom of the late 1990s in the US and the 1987 share market surge in Australia – both of which were followed by 50% or so share market falls which took years to recover from. This note provides a comparison between the Australian share market today and the experience during the US tech bubble and the 1987 bubble.
A comparison to 1987 and tech boom
The following table provides a comparison of key market indicators for Australian shares today with those of 1987 and US shares at the time of the tech boom.
Australian shares now v 1987 and tech boom
|
|
Aust shares Sept 1987 peak
|
US shares March 2000 peak
|
Aust shares now
|
|
Prior 12 mth share price gain, %
|
88.4
|
20.4
|
32.2
|
|
Prior 3 yr price gain, %pa
|
47.0
|
24.5
|
21.1
|
|
Profit growth (EPS):
|
|
|
|
|
– last 12 months, %
|
24.5
|
27.1
|
26.3
|
|
– last 3 years, %pa
|
19.7
|
9.0
|
23.9
|
|
Historical PE, times *
|
20.4
|
31.3
|
18.1
|
|
– prior 10 year avg of PE, times
|
11.0
|
22.6
|
21.3
|
|
Forward PE, times *
|
15.8
|
24.3
|
15.4
|
|
– prior 10 year avg of forward PE
|
NA
|
16.1
|
15.2
|
|
Inflation, %
|
8.5
|
2.4
|
3.0
|
|
10 year bond yield, %
|
12.5
|
6.0
|
5.7
|
|
Fwd earnings yld less bond yld, %
|
-6.2
|
-1.9
|
0.8
|
|
Dividend yield, %
|
2.5
|
1.1
|
3.5
|
|
Dividend yield less inflation, %
|
-6.0
|
-1.3
|
0.5
|
* The historic PE is based on reported earnings while the forward PE is based on 12 month ahead consensus earnings expectations.
Source: Thomson Financial, AMP Capital Investors
Several points stand out:
Firstly, the recent rate of gain in share prices is nowhere near comparable to the surge into the 1987 share market top. The gain in the Australian share market over the three years prior to its September 1987 peak was more than double the gain over the last three years.
Secondly, unlike in the run-up to the 1987 and 2000 share market peaks, share market gains this time around have been broadly in line with profit growth. This is consistent with the chart below, which shows share market gains since 1980 compared to growth in economy-wide profits. The 1987 boom in Australia saw share prices rise well above profits, whereas in recent years share prices have been catching up to profits after the 2002-03 bear market. (Note the profit data shown in the graph is sourced from profits reported to the Australia Tax Office, which tend to be more conservative than the earnings per share data shown in the table. Profit data on this basis is only available up to the December quarter last year).
Source: Thomson Financial, AMP Capital Investors
Thirdly, thanks to the strength in earnings growth valuation measures are far more favourable today:
· The ratio of share prices to earnings (PE) rose well above its long term (10 year) average in the case of Australian shares in 1987 and US shares in 2000, whereas today the historical PE for Australian shares is below its 10 year average and the forward PE is only marginally above its long term average. Australian shares are still trading well below their 1999 peak forward PE of 18.3 times.
· The 1987 bubble was associated with much higher inflation and hence bond yields. One way to allow for this is to compare the earnings yield on shares (which is the inverse of the PE) to the bond yield. In both the 1987 and 2000 episodes the forward earnings yield on shares was below the bond yield (see second last row) whereas in Australia today it is still above the bond yield.
· Similarly, the dividend yield today compares far more favourably than was the case in 1987 or in the US at the time of the 2000 tech peak. The real (ie, after inflation) dividend yield is now a positive 0.5% and compares to -1.3% for US shares in March 2000 and -6% for Australian shares in September 1987.
Other points worth noting regarding the 1987/2000 comparisons include the following:
· The 1987 share price bubble in Australia was associated with rapid growth in corporate debt and gearing, asset churning and highly speculative developments by a group of entrepreneurial stocks (eg Bond Corp, Qintex, etc). In fact, the entrepreneurs were so significant they had their own share market sector. By contrast corporate debt/gearing is now relatively low and the huge profit growth being generated by resources companies is real.
· This contrast also applies to comparisons versus the tech and dot com stocks of the late 1990s. Whereas the tech heavy Nasdaq and internet stocks were trading on exorbitant PEs (100 times or more) at the market peak, major resource stocks like BHP and Rio are currently trading on a PE of around 13 to 14 times, which is below the overall market PE.
· The last few years have seen a huge increase in merger and acquisition (M&A) activity, which some fear is a sign of a market top. This is being driven by cashed up balance sheets, the low cost of financing (eg, bond yields below earnings yields) and a desire to cut costs and expand market share. However, M&A activity expressed in relation to the overall value of the market is still low by late 1980s standards suggesting it could still have a long way to go.
Source: Deutsche Bank
· Finally, it’s not as if Australian shares have been rising on their own. Since March 2003 shares in emerging markets, Asia, Japan and Europe are all up strongly more strongly than Australian shares (in local currency terms). Into the 1987 peak Australian shares surged beyond global shares, as did the US market into the 2000 tech peak.
Risk of a correction, not a crash
After a 12% surge year to date the Australian share market is vulnerable to a correction in the months ahead, as are global shares generally. Potential triggers include the global back up in bond yields, an intensification of inflation and interest rate fears, worries about the impact of higher oil prices and a likely monetary tightening in China. Last year saw two 8% top to bottom corrections in Australian shares (around April and then again in October) and it wouldn’t be surprising to see another correction this year, perhaps as big as 15%. However, this is likely to occur in the context of a still rising trend:
· The boom in shares is still nowhere near as strong as was the case in 1987 or 2000.
· The Australian share market has moved closer to the mid point of our fair value range – which is now around 5700 reflecting a continuing rise in earnings. But it is still not expensive. See the next chart.
Source: Thomson Financial, AMP Capital Investors
· The profit outlook remains reasonable.
· The global and Australian outlook for solid low inflationary growth remains intact; and
· While monetary conditions are gradually tightening globally, and there is a risk of one more interest rate hike in Australia, they are still relatively supportive of shares.
A correction to let off a bit of steam would in fact be a favourable development. There is a growing risk that a bubble is starting to develop in Australian shares – on the back of the China/resources story – which could take the market well beyond fair value towards the top end of the valuation range in the chart above (currently around 6300). Such a blow-off would set the market up for a sharper fall later on. Fortunately we are not there yet – but valuations and comparisons with the 1987/2000 episodes are worth keeping an eye on.
Concluding comments
The boom in Australian shares in recent years is not comparable to the 1987 bubble or the tech boom in US shares. Share price gains have been far more restrained relative to profit growth such that valuations remain reasonable and are a long way away from bubble extremes. While shares are at risk of a correction, there is nothing to indicate a major crash or the start of a bear market around the corner. Of course, if Australian shares continue to accelerate higher as they have so far this year then the risk of a more significant set back occurring down the track will rise, but we are not there yet.
By Dr Shane Oliver, head of investment strategy and chief economist with AMP Capital Investors.*
