Irrational excitement on ASX boosts valuations as reporting season looms

The Australian sharemarket has just had its best day in more than two months but is it just FOMO’s effect? August’s reporting season could be a potential reality check for valuations.

TenCap lead portfolio manager Jun Bei Liu. Picture: Nikki Short

Fear of missing out on the rally was palpable last week as the ASX soared to record highs.

“FOMO” might now cause an inverse meltdown or, for want of a better term, a somewhat irrational “melt-up”.

In its best day since April, the ASX on Friday rose 1.4 per cent to a record high close of 8757.2 points.

A 2.1 per cent rise for the week made it the best week in almost three months.

The ASX 200 was up 7.3 per cent for the calendar year to date and 22 per cent above its April low.

CSL soared 3.6 per cent, the big four banks and Macquarie rose between 0.9 and 1.3 per cent, and BHP added 3 per cent on Friday, while Mesoblast rocketed 35 per cent on a strong update for the drug Rynocil.

But the August reporting season looms as a potential reality check for valuations.

Quarterly inflation data is due next week, and interest rate cuts are almost certain to resume in August after the jobless rate unexpectedly spiked to a 43 month high of 4.3 per cent in June.

While magnified by sample rotation effects, the rise in unemployment at a time when inflation has returned to the target band calls for the RBA to take out “insurance” against a possible recession by cutting the cash rate target toward the midpoint of its “neutral” estimates around 2.8 per cent.

Investors are betting that interest rate cuts will lift corporate earnings growth more than analysts expect, or at least allow stocks to keep trading on historically elevated multiples of earnings per share.

Some rebound in earnings per share and high price-to-earnings multiples is already embedded into current share prices. Aggregate consensus earnings-per-share growth estimates for financial year 2025 and ’26 are minus 1.7 per cent and plus 5.5 per cent respectively.

Stock valuations are typically based on next 12 months’ EPS and – as of Friday – that multiple had swelled to 19.4 times which is 31 per cent above its long-term average of 14.8 times.

It was the highest valuation for the local sharemarket since early 2021.

The market was trading on a dividend yield near 3.3 per cent, the lowest since late 2020.

But that was a time of fiscal and monetary policy stimulus during the pandemic.

Despite expectations of three or four more interest rate cuts, policymakers are unlikely to go back to “peak stimulus” without another crisis, so the main bet has to be that earnings will beat estimates.

CBA has been trading on a 12-month forward PE multiple of about 30.9 times.

That’s about 2.3 times more than its pre-2020 average of about 13.3 times.

BHP chief executive Mike Henry was upbeat on Friday about China’s “ongoing ability to grow its overall export base despite a significant decline in exports to the US”.

However, the risk is that earnings guidance will be somewhat restrained by the trade war and the consequent delays in expected US interest rate cuts. Analysts could keep downgrading their next 12 months’ EPS earnings estimates as they have done since the trade war broke out in April.

TenCap’s Jun Bei Liu and Jason Todd at their Sydney office. Picture: Nikki Short

The 2025 financial year is the third consecutive year of EPS contraction for the ASX 200.

At some point investors will lose patience with the long-awaited rebound in corporate earnings.

But there’s no shortage of bulls. TenCap chief investment officer Jason Todd says stock markets are “showing a high degree of resiliency through their repeated ability to absorb downside risks”.

Lead portfolio manager Jun Bei Liu expects earnings to bottom out this August reporting season.

Moreover, she doesn’t believe valuations are a constraint on the upside.

The fund managers think the ASX 200 can achieve a calendar year return near 15 per cent.

Before dividends, it implies that the index could push up to around 9000 points by the year’s end.

The pair are rightly more optimistic than the consensus on the ability of equities to absorb and work through downside risks for most of 2025.

“We took the view that when US President Trump paused the implementation of tariffs on April 9 that was the peak in uncertainty,” Mr Todd says. “Since then we’ve ridden the wave higher.

“We have an optimistic outlook on the macro backdrop and from an equity perspective, whether it is international or domestically, we think the market will be meaningfully higher by year end.

“If you’re not long, you need to get long, and we think you just stay long unless we see these risks amplify.”

The current set of risks – ongoing tariff negotiations, elevated geopolitical events like the conflict in the Middle East, volatile commodity prices, and widespread distrust in the equity rally – aren’t enough to change his view, as positive drivers are also gaining momentum.

“We expect equities to continue climbing a wall of worry through the second half of 2025,” Mr Todd says.

Ms Liu expects mid and small cap companies to have a better year than some of the large caps.

Domestic cyclicals are another area that should do well with early signs of the housing recovery becoming more pronounced, and consumer sentiment improving.

“Domestically, we are very confident that policy rates are coming down. For cyclical areas, whether it be consumer or interest rate-sensitive areas, that’s generally a very positive driver,” she says.

Her portfolio is overweight on the key beneficiaries of this, and has investments in JB Hi-Fi, REA Group, Seek and Universal Store where she foresees a clear path to earnings upgrades as confidence improves.

“We think the earnings environment will begin to bottom out this August reporting season and we’ll start to see some positive operating leverage. Valuations are not going to be a constraint,” Ms Liu says.

Other bullish bets include Virgin Australia, Greatland Resources, GemLife Communities Group.

Originally published as Irrational excitement on ASX boosts valuations as reporting season looms