CRITERION: Share valuations look overheated, but it’s a tale of two sectors

The local market is trading at elevated earnings multiples relative to the historic run rate
The valuation strength is attributable to industrial stocks and not the miners
Bull markets can often continue well beyond ‘sensible’ valuation levels

The stock market’s resilience in the face of adversities has prompted intensifying chatter that things have got too frothy and that a substantial correction is in in order.

At the time of writing, the ASX200 index had retracted 2 per cent from a record 8384 points on October 17.

We don’t claim to be Nostradamus in divining the market’s direction. Or Warren Buffett, who reckons markets are exhibiting “casino-like behaviour” and expects a GFC-like retraction when stocks fell – gulp – by more than 50 per cent.

According to a Morgan Stanley note this week, earnings per share (EPS) growth expectations have retraced to “near zero”, with the key AGMs to date suggesting little near-term upside.

“With valuations where they are, there is little buffer to absorb … any exogenous shock,” the firm opines.

“Indeed, for meaningful upside from here, earnings trends need to start to improve.”

‘Exogenous shocks’ presumably include rising ten-year US bond yields, which factor in shortening odds of a Donald Trump victory next week (and execution of his signature tariff increase policies that could both spur inflation and reduce demand).

Broker Wilsons notes the overall market is trading on a price-earnings (PE) multiple of 18.3 times over the last 12 months, compared with the 10-year average of 16 times – a 14 per cent over valuation.

“Calendar 2025 earnings growth is expected to improve, but only to a still moderate 5 per cent,” Wilsons says. “This compares to [ASX200] index gains over the past 12 months of 18 per cent.”

A quirk of the bull market is that the PE expansion is almost entirely attributable to the industrials sector, which is on a multiple of 20.7 times compared with the 10-year average 16.9 times.

The most valuable ASX stock, the Commonwealth Bank (ASX:CBA) is on a multiple of around 23 times, a whopping 46 per cent premium to its average 10-year multiple of 16 times.

Wesfarmers (ASX:WES) is on a multiple of around 29 times – 34 per cent over the odds – raising the question of whether we finally have reached ‘peak Bunnings’.

“In contrast, apart from the uptick in the past few weeks on China stimulus hopes, we have not seen any significant re-rating in the resources sector with the sector’s multiple quite close to average at around 13 times,” says Morningstar.

Indeed, BHP (ASX:BHP), Woodside Petroleum (ASX:WPL), Fortescue (ASX:FMG) and Santos (ASX:STO) lag their historic multiples, the most notable being BHP’s 17 per cent discount.

Morningstar reckons that with the overall market trading at a 9 per cent premium, “we are no longer awash” with cheap options.

“We’re seeing larger-cap stocks more richly priced and some watchers worried about soaring valuations on stock prices and frothy trading,” the firm says.

Investors are starting to get the message.

According to Morningstar, Westpac shares had the heaviest selling pressure in the month of September – and by some margin – followed by the CBA, Macquarie Group (ASX:MQG) and BHP.

Healthcare giants CSL (ASX:CSL) and ResMed (ASX:RMD) are also unpopular, as are Mineral Resources Mineral Resources (ASX:MIN) and Woodside .

On Wilson’s numbers, the tech sector trades on a whopping forward PE multiple of 95 times, compared with the 10-year average of 39 times.

But in contrast to the banks, the “sector has delivered significant growth over recent years and is expected to continue to grow rapidly over coming years.”

History shows that bull markets can perpetuate well beyond ‘sensible’ valuations, but gravity prevails eventually.

But the optimists may take perverse solace in the actions of Warren Buffet’s Berkshire Hathaway, which more than halved its stake in Apple in April and missed out on US$23 billion of upside.

This story does not constitute financial product advice. You should consider obtaining independent advice before making any financial decision