Australian equity valuations not overvalued says RBA’s Kohler

If you had put $100 into the equity market in 1900 in a portfolio that tracked the stock market index, you would have over $100,000 today.

By William McInnes  13 Dec 2018  Australian Financial Review

The Reserve Bank of Australia says Australian equities are not overvalued and highlighted the outperformance of equities compared to other asset classes over time.

Speaking at the Australasian Finance and Banking conference in Sydney on Thursday, the central bank’s head of domestic markets, Marion Kohler, said there was no reason to view local shares as overvalued.

“In the global low-interest environment of recent years, some commentators, including the Reserve Bank, have raised the prospect that this has led to a ‘search for yield’ by global investors, where they bid up the price of risky assets and thus increase the risk of a sharp correction down the road,” she said.

“One simple way of measuring this for the equity market is a price-to-earnings ratio. By this measure, Australian equities are not showing signs of heightened valuations.”

Dr Kohler attached a graph to her presentation showing that Australia’s price-to-earnings ratio was much lower than that of the United States.

A good option

She said the local sharemarket has been a good option for investors, with strong returns available over the long-term compared to bonds and bank deposits.

“Over the long run, equities have been worth much more to investors than other investment options. They have returned about 5 percentage points more than long-term bonds on average each year,” she said.

“This accumulates to a very large amount of money over a long period of time. If you had put $100 into the equity market in 1900 in a portfolio that tracked the stock market index, you would have over $100,000 today after adjusting for inflation; this is more than 100 times what you would have earned from a Government bond or a bank deposit.”

Since 1993, Australia has had a higher total return on equities the UK, European and World MSCI indices which Dr Kohler believes is due in part to franking credits.

Over the past 25 years Australian stock prices have gone up a bit less than the rest of the world, particularly the United States,” she said.

“But Australian companies pay high dividends, due in part to the specific tax treatment they receive. I am referring to franking credits, which were initially introduced in 1987. Taking this into account, Australian stocks have generated above-average returns over the past 25 years.”


Dr Kohler sounded one note of caution around equity markets in her speech, however, highlighting the risks investors face when investing in shares and pointing to the huge losses suffered by equity investors during global financial crisis.

“The equity market is more volatile than many other markets. Average volatility in the returns generated by equities is double that of bonds,” she said.

“This means that at any point in time, investors get a return that can be very different from the average return. Developments such as the global financial crisis have emphasised this. In the middle of the financial crisis, share prices fell by around 50 per cent. If you had a superannuation portfolio based on equities, the value of your retirement funds would have declined significantly, and remained lower for quite some time.”

Dr Kohler also discussed substantial shifts in market composition, noting the weighting of the resource sector in the overall market has fluctuated during the past five decades.

“The resources sector has tended to expand and contract with mining booms and commodity prices,” she said.

“During the mining boom of the 2000s, the share of the stock market capitalisation accounted for by resources companies doubled over a period of about five years. But this pales in comparison with the experience of the late 1960s boom, where the resources sector was worth at its peak in 1970 around 65 per cent of the exchange by market capitalisation.”

Original article here

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