Speaking at a presentation in Sydney yesterday, Wingate Asset Management chief investment officer Chad Padowitz said equity valuations have been “substituted for a lack of yield elsewhere” which has benefited valuations greatly.
Mr Padowitz said this resulted from the yields from blue-chip stocks such as Johnsons & Johnsons strongly diverging above that of 10-year Treasury bonds from around October 2011.
However, with the share price rising and dividend yields falling, Mr Padowitz believes this gap between 10-year Treasury yields and dividends yield is now disappearing.
“That takes away a lot of the support we’ve had till now,” said Mr Padowitz.
“On a price/earnings basis, things aren’t ridiculously expensive, but what that does mask is that earnings of sales margins are pretty high,” he said.
During the last 25 years, price to sales has only been higher in the ‘dot-com era’ where a number of companies were trading at “100 times sales”, Mr Padowitz added.
“If we look at earnings growth expectations, globally the market is expecting earnings growth of 14 to 15 per cent over the next two years per years; the long-term average is six per cent,” he said.
“Five years into recovery with rates trending up and potentially wage growth coming up, this seems like a big ask in our opinion.”
Mr Padowitz said any weakness in earnings growth will begin to bring valuations down.
“A year to date there hasn’t actually been much earnings growth – if that doesn’t pick up then earnings per share will have to come down and then there will be some risk to the market valuation,” he said.
