Australian equities are overvalued and due for a correction, experts have warned.



Michael Karagianis

Australian head of Ibbotson Associates, Daniel Needham, said at the Morningstar conference last week that the multi-manager was bearish on Australian equities.

It was a view backed by other industry experts – MLC Investments Management Investment Strategist, Michael Karagianis (pictured) and Schroders head of fixed income and multi-asset, Simon Doyle.

“Longer-term we see [Australian equities] as overvalued, and depending on what kind of metric you use we see it as significantly overvalued,” Needham said.

Analysts at Ibbotson have been looking beyond the conventional measures – trailing price earnings and price-to-book ratios – which are in line with historical averages, to arrive at their views.

Needham told the conference that when earnings were normalised during the economic cycle, there was often limited capacity for companies to eke out further profits.

“Historically, certainly before 2004, profit margins for Australian companies averaged probably around 5 per cent or a little bit below, and since 2005 we have had profit margins averaging about 10 per cent plus,” he said.

“That level of profit margin is probably unsustainable, and when you drill down into the Australian stock exchange and look at where those earnings have come it is from margin expansion and there hasn’t been any real volume growth since 2005.”

Karagianis agreed with this downbeat outlook for Australian equities, saying that beyond commodity-linked businesses, companies were having margins squeezed by a higher Australian dollar, increased labour costs and interest rate hikes.

“It comes down to future earnings and if you look at the Australian market at the moment, one of the issues we are seeing and why the market is under-performing is that earnings are not performing as well as many other markets offshore,” Karagianis said.

The three experts were in agreement that, as well as operating in a tough domestic landscape, Australian companies also faced an uncertain global economic environment.

Doyle noted that valuations for Australian equities were not the only issue, and said economies in the US and Europe faced significant structural problems due to unsustainable debt levels.

“From the perspective of an investor, the world is high-risk, and I think that risk is a real concern for the Australian share market,” Doyle said.

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