‘It’s dangerous’: The ASX is overvalued so buckle up for a reality check

July is normally a good month for Australian stocks, but there are good reasons to be cautious.

The ASX 200 has surged to another record high. Picture: NewsWire/ Gaye Gerard

The ASX 200 has roared back to life since its February-April swoon, setting a record high daily close of 8597.75 points on Wednesday.

The trouble is, the rebound has been entirely driven by a price-to-earnings multiple expansion.

Unlike the US market, where consensus earnings forecasts have been revised up because of the ongoing boom in artificial intelligence, ASX earnings estimates have been revised down since April.

The result is that the next 12 months PE multiple of the ASX 200 has soared to around 19 times, a level only exceeded during peak fiscal and monetary policy stimulus in the pandemic.

The long-term average “forward PE” for the ASX is about 14.75 times. On that basis it’s about 29 per cent overvalued. Some will focus on cyclically adjusted PE multiples but on face value it’s expensive.

Another way of looking at it is the ASX 200 now exceeds Bloomberg’s “bottom up” derived index level (using the consensus 12-month price targets for all companies in the index). The 20-year average is a discount of about 379 index points. The physical index now exceeds that long term average by about 80 points.

MST senior research analyst Hasan Tevfik. Picture: Julian Andrews

Unless another round of “peak” stimulus is coming (unlikely), or the analysts are wrong and the market is set to “grow into” its frothy PE multiple (possible but unlikely), investors might not be prepared to keep paying such high multiples of earnings for stocks.

July is normally the best month of the year for a variety of reasons.

But at these levels, the starting point valuation should be a key concern for investors.

In that regard the return potential from Australian shares over the medium term appears limited.

“It’s dangerous and CBA is at the epicentre,” says MST senior analyst Hasan Tevfik.

He estimates that CBA now trades on a phenomenal next 12-month PE multiple of 30 times.

If it were to de-rate to 16 times, he estimates that CBA alone would shave 500 points off the ASX.

For the overall market, Tefvik says an abnormal supply-demand situation has pushed the “starting point” valuation for the ASX up to a level where, on a historical basis, it would be expected to underperform bonds and possibly even cash on a five-year basis.

Tevfik has been a bull in recent years and that has worked out well. The ASX has risen 16 per cent over the past two years and is currently up more than 5 per cent for the year to date.

But like many of the sell-side analysts who have been downgrading their earnings estimates this year, he’s losing patience in an expected pickup in Australian corporate earnings.

At the same time he’s concerned about some of the valuations that major stocks are trading on.

That recently led him to slap a below-consensus price target of 8000 points on the ASX 200 for December. From the current level around 8590 that implies a 7 per cent fall.

Of course the ASX would not be historically “cheap” on a 12-month forward PE basis at 8000 points.

The ASX would not be historically ’cheap’ on a 12-month forward PE basis at 8000 points.

It could sustain somewhat elevated PE multiples because of the supply-demand dynamics that Tevfik is focusing on. A more sustainable kicker would be an upgrade cycle for global growth. However, global growth estimates are currently in a downgrade cycle.

Much depends on US President Donald Trump’s “reciprocal tariff” settings, due to be announced by the July 9 deadline.

But the best guess from economists is that the average US tariff will settle at 14.5 per cent versus 3 per cent rate before the increases this year. That would take the average US tariff to the highest rate since 1938.

Negative earnings updates from corporate Australia in recent months have featured names like Myer, IDP Education, Cettire, Accent, KMD Brands, Adairs and Reece.

Any companies that need to do so will update the market before the August reporting season.

But even if more companies don’t cut their guidance, the downgrade trend among sell-side analysts is well established. The macroeconomic data have been pretty soft, particularly in regard to the domestic economy and China. If the US goes into recession, the earnings outlook will crumble.

After the February reporting season, ASX 200 profit growth for the year to June 2025 was expected to be 1 per cent, but that has fallen away to minus 2.3 per cent. If realised in the August reporting season, it will be the third consecutive year of EPS contraction for the ASX 200.

Tevfik says the ASX has been carried higher by a “beta effect” from soaring US markets that has boosted the local market irrespective of what has been happening to earnings estimates.

He also points to another strong quarter of inflows from superfunds, stemming from a confluence of high wages growth, strong population growth and the super guarantee levy going up.

Another driver of Australian shares as global equities were “ripping” since 2023 was global fund managers continually rebalancing from the soaring US tech stocks to non-tech stocks in Australia.

Originally published as ‘It’s dangerous’: The ASX is overvalued so buckle up for a reality check