Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 253

Little room for error in equity markets now

The key reason for concern about exposure to equity markets is the over-pricing in much of the market in the US, Europe and UK. The US stock market makes up more than half of the global market capitalisation and what happens in the US echoes around the world.

We have been relatively bullish on US shares since the start of the current ‘Quantitative Easing’ and technology boom, especially stimulated by smart phones, since 2012. It has been a tremendous rally, with the US broad market returning an incredible 140% in the past five years led by tech giants Apple, Amazon, Facebook, Google, Microsoft, and the like. The problem is not profits or dividends as both have been rising strongly during the boom, and the current profit reporting season has seen more double-digit profit growth. The problem is that everybody has come to expect double digit profit growth as the norm, but it is not sustainable and never has been.

Downside risk now dominates

Prices are so high and profit growth so strong that there is now little room for error. We are at a point where there is more downside than upside. The chance of share prices doubling in the next year or so is small, but share prices could easily fall dramatically and languish for years – as they have done several times in the past.

The chart below shows the broad US stock market index in real (inflation-adjusted) terms (blue line) since 1900. The green line shows aggregate annual company earnings (profit) per share across the market. Profits oscillate up and down wildly through booms and busts. The maroon line is the 10-year average real earnings per share. This is much smoother.

Real profit growth (maroon line) has averaged just 2% per year for the past couple of centuries. In that time, America has grown from being an ‘emerging market’ to the largest economy in the world in which its leading companies dominate most industries on the planet. Even in recent decades, real profit growth has still averaged around the same 2% per year.

Click to enlarge

Watch for complacency

Company profits (green line) rise strongly in booms as they are doing now. The problem is that whenever the green profit line rises too far above the maroon trend line as the booms progress, people become complacent and set their expectations too high. They expect double-digit growth to last forever. Whenever boom-time profits reach beyond about 30% above the long-term trend, share prices tend to snap back sharply in sell-offs. The last big sell-off was the 2008-2009 ‘GFC’.

The profit line is currently 30% above its long-term trend and that is on a par with numerous prior booms before sell-offs. So we are in dangerous territory. A further concern is that the current market expectations of profits for the next couple of years (red line on the far-right end of the green profit line) is for further astronomic profit growth, heading into the stratosphere.

For the current tech boom to continue at the same pace as it has been to date, Apple, Amazon, Facebook, Google, Microsoft, etc would need find a new planet, fill it with another 7 billion people and then sell phones, apps and software to them all within the next few years! Elon Musk at Tesla is doing his best, but it will not be quick enough.

 

Ashley Owen is Chief Investment Officer at advisory firm Stanford Brown and The Lunar Group. He is also a Director of Third Link Investment Managers, a fund that supports Australian charities. This article is general information that does not consider the circumstances of any individual.

 

RELATED ARTICLES

Buy the dips?

Amid a tornado of headlines, where can investors find opportunity?

Cyclical stocks will drive markets higher in 2025

banner

Most viewed in recent weeks

Why the $5.4 trillion wealth transfer is a generational tragedy

The intergenerational wealth transfer, largely driven by a housing boom, exacerbates economic inequality, stifles productivity, and impedes social mobility. Solutions lie in addressing the housing problem, not taxing wealth.

The 2025 Australian Federal election – implications for investors

With an election due by 17 May, we are effectively in campaign mode with the Government announcing numerous spending promises since January and the Coalition often matching them. Here's what the election means for investors.

Finding the best income-yielding assets

With fixed term deposit rates declining and bank hybrids being phased out, what are the best options for investors seeking income? This goes through the choices, and the opportunities and risks involved.

What history reveals about market corrections and crashes

The S&P 500's recent correction raises concerns about a bear market. History shows corrections are driven by high rates, unemployment, or global shocks, and that there's reason for optimism for nervous investors today. 

Howard Marks: the investing game has changed

The famed investor says the rapid switch from globalisation to trade wars is the biggest upheaval in the investing environment since World War Two. And a new world requires a different investment approach.

Welcome to Firstlinks Edition 605 with weekend update

Trump's tariffs and China's retaliatory strike have sent the Nasdaq into a bear market with the S&P 500 not far behind. What are the implications for the economy and markets, and what should investors do now? 

  • 3 April 2025

Latest Updates

Investment strategies

4 ways to take advantage of the market turmoil

Every crisis throws up opportunities. Here are ideas to capitalise on this one, including ‘overbalancing’ your portfolio in stocks, buying heavily discounted LICs, and cherry picking bombed out sectors like oil and gas.

Shares

Why the ASX needs dual-class shares

The ASX is exploring the introduction of dual class share structures for listed companies. Opposition is building to the plan but the ASX should ignore the naysayers and bring Australia into line with its global peers.

The state of women's wealth in Australia

New research shows the average Australian woman has $428,000 in net wealth, 40% less than the average man. This takes a deep dive into what the gender wealth gap looks like across different life stages.

Investing

The two most dangerous words in investing

Market extremes are where the biggest investment risks and opportunities lie. While events like this are usually only obvious in hindsight, learning to watch out for these two words can alert you to them in real time.

Shares

Investing in the backbone of the digital age

Semiconductors are used to make microchips and are essential to a vast range of technology and devices. This looks at what’s driving demand for chips, how the industry is evolving, and favoured stocks to play the theme.

Gold

Why gold’s record highs in 2025 differ from prior peaks

Gold prices hit new recent highs, driven by a stronger euro, tariff concerns, and steady ETF buying – all while the precious metal’s fundamental backdrop remains solid amid a shifting global economic landscape.

Now might be the best time to switch out of bank hybrids

In this interview, Schroders' Helen Mason discusses investing in corporate and financial credit securities, market impacts of tariffs, opportunities for cash investments, and views on tier two and hybrid bonds.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.