With Australia’s economy growing at its slowest pace in decades and expectations interest rates could soon start to fall, analysts are warning there is too much “exuberance” on the share market.

In what was an ominous start to corporate reporting season last month, the Australian share market shed more than $100 billion during a massive global sell-off that was sparked by concerns about a potential US recession.

But after that temporary blip, the ASX 200 rebounded. It has since climbed to near-record highs, despite an underwhelming corporate reporting season.

In the past few weeks, hundreds of companies opened up their books to deliver full and half-year results to investors, giving Australians a look at just how the corporate world, and the broader economy, are faring.

Some of our largest companies reported better-than-feared profits — though expectations were quite underwhelming.

Prior to the August reporting season, UBS predicted earnings, on average, would fall 3.5 per cent in the 2024 financial year. That came off the back of a 2.9 per cent drop in the previous year.

Analysts said last month’s results were “in line” with their low expectations, while many others downgraded their forecasts for future earnings.

“Overall, earnings were actually downgraded around 4 per cent into next year,” Anna Milne, a senior analyst at Wilson Asset Management, said.

“But what was most surprising was probably the market’s reaction to that. Markets just shrugged it off and continued their march.”

Last week’s GDP data confirmed a severe economic slowdown as consumers continued to grapple with cost-of-living pressures and a “per capita recession”.

Despite the gloomy picture, the ASX is trading close to record highs as investors anticipate central banks will deliver significant interest rate cuts in the months ahead.

In general, lower rates mean people earn less money on their bank deposits, which creates an incentive for them to take risks and seek a better return elsewhere, such as the share market.

The European Central Bank is widely expected to cut rates on Thursday, while the US Federal Reserve has signalled it will almost certainly slash borrowing costs next week.

Inflation is much lower in Europe and the United States than in Australia, however, which means the Reserve Bank (RBA) is resisting the idea of rate cuts here until consumer prices start growing at a much slower pace.

At this stage, money markets are betting the RBA will start cutting rates from February, but they have been frequently wrong in the past. 

The ASX and its ‘lofty valuations’

Globally, stock markets are sitting just below record highs, including here in Australia, despite last month’s brief burst of volatility.

UBS analyst Richard Schellbach said what they were observing were “lofty valuations” in the ASX 200 despite a less-than-stellar corporate reporting season.

Investors remain positive about the outlook for the next 12 months, despite it being dependent on continued earnings growth, how soon the rate cuts begin, and our ability to weather China’s economic slowdown.

But Mr Schellbach believes there are reasons to be optimistic about company growth and the trajectory of the share market.

“We think the elevated levels are justified because our base case remains that a soft landing is engineered here in the Australian economy,” he told the ABC.

“And given the high quality of Australian companies, particularly the larger caps on the listed equity market, we believe that valuations that are at a higher level than the historical average are justified because these businesses have shown themselves to be able to navigate business cycles so well.”

Miners were some of the worst performers throughout corporate reporting season — mainly due to China’s struggling economic recovery, which has led to less demand for Australian commodities such as coal and iron ore.

Overall, Mr Schellbach observed that in this economic climate, the largest companies were performing better than most.

“Certainly what we’re seeing — and this fits in with the winner-takes-it-all cycle that we’re in — the best retailers, the best banks, the best industrial companies are weathering the storm so much better,” he said.

“They are gaining market share, and we expect this to continue into the future.”

But smaller and medium-sized businesses are not faring as well, Mr Schellbach said, as they struggled with cost management, the ability to maintain profit margins and losing market share to more dominant brands.

Commonwealth Bank shares in the spotlight

One of the companies that has attracted the most interest in recent months over its valuation is Commonwealth Bank.

CBA’s share price has surged 40 per cent over the past year, and is trading near record highs.

That was despite the fact its net profit was $9.5 billion, dropping 6 per cent in the last financial year, though it was far higher than other stocks on the ASX.

The bank also noted in its results that mortgage competition was increasing, along with bad debts, while net interest margins (which is the gap between what the bank pays to borrow money and the interest rates it receives from lending it out) were under some pressure.

Analysts normally point to CBA’s “forward price to earnings ratio” as a sign that its shares are “overvalued”.

It is basically a comparison of the company’s share price with its estimated “earnings per share” over the next 12 months. On that measure, CBA’s score is 24.

The result was “extraordinarily high”, according to VanEck Australia’s deputy head of investments Jamie Hannah.

“Twenty-four times earnings puts them in line with a high-growth company, like a tech company that’s inventing new technology and finding new markets,” he said.

The chart below shows how expensive CBA’s shares are relative to its earnings, compared with other major companies on the ASX and Wall Street.

There are two key takeaways from the bank’s share price, according to Mr Hannah.

One is that “no-one is willing to sell” their CBA shares because investors, many of whom have likely owned their stocks for a while, are sitting on “big capital gains and have quite a big tax position if they’re going to sell”.

“Second of all, Commonwealth Bank makes up around 12 to 13 per cent of the ASX 200 [index] and most institutions need to hold some CBA [shares], otherwise they’re out of line with the broader market,” he said.

This applies especially to index funds (or ETFs) which track the performance of the share market.

“I just can’t see a world where the valuations are justified,” Ms Milne said.

“Although it might not happen next week or next month, I do expect the returns from here for the banking sector are quite limited.

She summed it up by reflecting that they remained cautious about the banks currently.

Consumers resilient but not across the board

While companies noted the distortions of COVID-19 had passed and Australia was experiencing a “normalisation”, cost-of-living pressure loomed large across the season.

Several companies, including Wesfarmers and Woolworths, talked about changes in consumer behaviour when they unveiled their profits, and the effect high inflation was having on their customers.

Analysts said that, for the most part, the consumer backdrop was more resilient than expected.

“We also saw that consumers out there are not a homogenous group,” Mr Schellbach said.

“Therefore, there’s enough consumers still spending to allow retailers to grow their top line. There’s still pockets of strength.”

Meanwhile, according to CommSec, just under $35 billion of dividends have been, or will be, paid to investors between August and October 2024, which is 5 per cent higher than a year ago.

Ms Milne said she was taking an interest in companies that paid high dividends, including “the likes of Telstra, Spark Infrastructure, Transurban, and the entire REIT [real estate investment trust] sector”.

The risks ahead

Looking ahead, Australia’s two biggest sectors — finances and resources — are under considerable risk right now due to interest rate cuts and sharp falls in commodity prices, according to analysts.

“The risks are still high because of where the market is, at all-time highs,” Mr Hannah said.

“But gold equities, some infrastructure, assets and property, if we avoid a recession, are some of the strongest areas for investors to be looking at.”

While there is a degree of uncertainty, he says we are more than likely going to avoid a recession.

“But it all depends on how the rest of the world influences Australia,” Mr Hannah warned.

He said if a recession were to happen it would “probably come from areas that we’re not necessarily expecting, which could come from offshore”.

The biggest uncertainty is around China’s economic slowdown and how that will impact Australia, particularly as its property slowdown impacts our two biggest exports: coal and iron ore.

“All these types of factors, which are somewhat outside of the Australian control — the US elections, the wars in Europe and the Middle East, as well as [the] Chinese slowdown — they’re impacting our economy, and they will be one of the things we’re going to have to watch out for,” Mr Hannah said.

Ultimately, Ms Milne remained relatively cautious on markets, but she said there were some areas of interest.

“‘[We’re] looking for those names that have been unloved. Either they have earnings turnaround stories or we think valuations have reached a level where they’ve become really compelling,” she said.