A longer term log chart of the All Ordinaries – are we at fair value?
Posted on 14 April 2010
Following on from our previous reflections on fair value for the All Ordinaries (find it here)…
Log charts are a misunderstood lot. For a start there’s a certain mystery just cause logarithm is a four syllable word. Also, they’re something of a party pooper – flattening the good-times exponential as they do.
Still, when looking at the longer term context they come into their own. Consider the following chart of the All Ordinaries since the peak of of 1987:
A couple of observations:
- Looks like we are approaching something like fair value based on this slice of history. In the bigger picture, oscillations around the middle of the channel could reasonably be ascribed to changes in valuation multiples.
- That the 50 day moving average would stall around these levels is pretty understandable. The post-87 sideways market is interesting in this regard – liquidity surged post the crash leading to a property bubble that was popped in the early 90′s – the equities market rallied hard from the 87 low before trading back down when the liquidity was removed. We similarly have entered a tightening phase.
Another way of viewing this longer term history is by overlaying the nominal price chart with an exponential growth curve:
Assuming earnings per share for the All Ords grew from around 60 cps in mid-1984 to 350 cps in mid-2010 (that’s being generous), then EPS grew by approximately 7% per annum. The green line illustrates what this would have looked like in planet Smooth – assuming all else is constant – which of course it wasn’t. Market multiples expanded across the period – P/E in mid-1984 was around 10.5x versus a current one closer to 15x (plus or minus a digit depending on what you consider ‘normalised earnings’). This would explain why the green curve rarely meets the index.
Conclusion
Fair value might be around here somewheres – if you assume that recent market multiples are appropriate and that earnings per share of 350 is sustainable. I’m not in that camp. We are heading into a higher interest rate world with household debt to disposable income some 4 times what it was in 1984. As we suggested the other day – a multiple closer to 12x is more appropriate (call it 4250 for XAO) – till then better steer towards the lower risk part of the curve.
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[...] on 14 April 2010 Following from the previous post (here) that suggested that ‘fair value’ for the All Ordinaries is around 4250 – just to [...]
All seems so obvious now in hindsight doesn’t it? That big run-up from about Dec 04 to Dec 07 (the first chart). We should have all been shorting our little pants off in 2007 (I hope you were, but I wasn’t).
A good chart to look at very month I daresay.
I’m learning as we go like the rest of us mere mortals!
[...] This isn’t a clarion call to abandon ship. It isn’t 2008 – with margined investors having their stock dumped into the market. Sure there may be a carry trade or three that needs to be unwound, but buying on margin has not regained its 2007 highs. For this reason, will be looking to add some long exposure at my estimation of fair value (see articles here and here). [...]