ASX 200’s record run raises questions as earnings forecasts plunge

As the sharemarket defies gravity, strategists say the mathematics don’t add up and investors betting heavily on future interest rate cuts are in vulnerable territory.

The Australian sharemarket’s relentless march higher has hit a curious contradiction. Earnings growth estimates remain weak but share prices keep climbing.

After touching a record high of 9054.5 early last week, the ASX 200 has dipped to 8891.2 as some major stocks trade ex-dividend. But the broader trend remains stubbornly upward.

The August reporting season delivered another round of earnings downgrades. Earnings per share forecasts for the ASX 200 were cut by 1.3 percentage points, according to MST’s Hasan Tevfik. That’s worse than the typical 0.8 per cent downgrade.

Yet the market gained 3 per cent through August. It has now delivered 15 per cent total returns over 12 months, despite facing a third consecutive year of earnings contraction.

“Earnings haven’t really driven the market at all,” Tevfik says.

“But a lack of earnings growth remains a headwind.”

Current earnings growth forecasts for June 2026 have slumped to 3.4 per cent from 7.5 per cent at the start of the year.

Some strategists worry about a fourth year of earnings declines.

Citi economists maintain a “cautiously optimistic” view based on their view of a recovering consumer sentiment and tight labour markets, but the bank’s equity strategists see aggregate earnings per share for the ASX 200 falling 0.2 per cent in FY26, well below the 5.6 per cent consensus growth estimate. Citi’s forecasts for copper and gold are well below consensus.

Betting on rate cuts

The market appears to be betting heavily on interest rate cuts providing relief. But Tevfik warns this strategy looks “quite dangerous” given stretched valuations.

“You’re sitting on stretch valuations,” he says. “You’re betting on a series of rate cuts, but the rate outlook is not going to deliver massive cuts unless there’s a deeper US downturn.”

Analysts have cut earnings forecasts but raised price targets by 2.3 per cent. That implies either much lower interest rates or lower risk premiums - neither of which looks likely.

With a forward PE multiple approaching 20 times, the ASX 200’s valuation is currently more than two standard deviations above the long-term average of 14.8 times according to Morgan Stanley.

Even the expected interest rate relief faces questions.

While most strategists see rate cuts as crucial support, Citi economists see a risk the Reserve Bank delivers fewer cuts than expected. Despite their “cautiously optimistic” outlook, they note improving domestic momentum and tight labour markets could limit the RBA’s room to ease policy.

Mixed beneath the surface

Beneath the headline numbers, the reporting season revealed stark divisions.

Financials performed strongly, helped by trading updates from Westpac and NAB plus solid results from QBE and Scentre Group.

Industrials suffered the worst downgrades. Big names like James Hardie, CSL, Woolworths and Telix all disappointed. The common thread was weaker revenues combined with insufficient cost cutting.

“For both industrials and commodity producers, the downgrade has come from weaker revenues and operating costs not being cut enough,” Tevfik notes.

One bright spot was the record number of share buyback announcements - 18 programs worth $6.3bn. But Tevfik cautions these aren’t large enough to drive the overall market.

Small caps shine

A notable trend has been the outperformance of smaller companies. Small caps gained 7.5 per cent in August versus 2.7 per cent for large caps, according to Morgan Stanley data.

This “broadening” of performance suggests some improvement in domestic conditions. Consumer stocks generally had a good reporting season, reflecting tentative signs of recovery in household spending.

The materials sector has also staged a comeback, outperforming industrials since late June. This appears linked to improving sentiment towards China, though concrete evidence of policy support remains limited.

Dangerous territory

The concern among strategists is that too much good news is already priced in. The market has followed the US in multiple expansion, but without the earnings growth to justify it.

“The multiple paid is at odds with earnings on offer,” Morgan Stanley’s Chris Nicol observes. “Aggregate earnings levels are anchored at multi-year lows.”

Tevfik warns the market sits in “vulnerable” territory. While domestic interest rate cuts may provide support, the global outlook remains uncertain.

The key risk isn’t necessarily domestic. With relatively benign local conditions, any correction is more likely to come from global factors - particularly if the US Federal Reserve delivers fewer rate cuts than expected.

What’s next?

For now, the market continues to defy gravity. Strong global equity performance, falling interest rates and tentative domestic recovery signs provide support.

But the mathematics remain challenging. Three years of earnings declines have left the market dependent on multiple expansion rather than fundamental improvement.

As one strategist puts it: “Full valuations are not in themselves enough reason to be underweight. But they do constrain medium-term upside and suggest latent vulnerability to any adverse global shock.”

The August reporting season may have been “good enough” for a bullish market. Whether that remains the case depends largely on what happens in the US.