The equity market is (relatively) cheap!
The extra-ordinary decline in local bond yields has now left the Australian equity market relatively cheap compared to bond markets.
Despite the S&P/ASX 200’s price-to-forward earnings ratio reaching a relatively high 16.1 at end-June (compared to an average of 14.2 since 2002), slumping bond yields have caused the so-called “equity-to-bond yield gap” to widen out to 4.9% (compared to an average of 2.9% since 2002).
If bond yields stay low – as seems likely given prospective interest rates cuts in both the United States and Australia – the local PE ratio could easily push higher. Indeed, if 10-year bond yields end the year at 1.25% (from 1.3%) then the PE ratio could reach 17.5, even with an equity-to-bond yield gap at a still relatively elevated 4.5%.
That could see the local S&P/ASX 200 index rise as much as 10% further – reaching 7,200 – this year even if forward earnings (based on current market expectations) remain relatively flat!