The ASX200 this week finally took out its previous record high set in November 2007, its been a long time in the making but it must be remembered that the Total Return Index (which includes dividends) gained all the ground it lost through the GFC by October 2013. This is important because Aussie companies typically have larger dividend payout ratios relative to international companies, and whilst the price index has taken a long time to return to pre-GFC levels capital has been returned to investors in the form of dividends.
There are a few factors in play, propelling the ASX to fresh record highs, counter intuitively they don’t include a healthy economy and robust corporate earnings outlook. But the ASX200 has defied this dynamic rallying 21% year to date and beneath the surface of the market’s strong performance a "valuation paradox" bubbles. On the one hand, growth, inflation and earnings are all slowing, meanwhile economic growth in China (Australia’s largest trading partner and the global credit engine) is ailing. At an index level, expectations for FY19 earnings growth is lacklustre, FY19 EPS estimates for some sectors of the market have fallen from +9% to just +1%, consistent with the exhausted growth outlook.
The main driver has been central bank policy and a dovish symphony from central banks around the globe. Interest rates in Australia will be lowered again and are set to stay low for an extended period as we heard last week from Governor Lowe, who echoed notoriously dovish central bankers ACB President Mario Draghi and BOJ Governor Kuroda. In this low rate environment, cash is set to yield very little and this tempts savers to climb up the risk spectrum into higher yielding assets.
Lower interest rates also feed into share price valuations. Whereby a lower discount rate increases the present value of future cash flows, justifying higher valuations as interest rates fall, even when economic and earnings growth may be weak thus fueling multiple expansion. Despite sluggish economic growth softening profit outlooks. And that’s why we have seen blue sky growth stocks, like Appen, Afterpay and Wisetech bid up significantly and outperform the broader market.