All Ords breaks 6000

The All Ordinaries Index broke resistance at 6000, signaling a primary advance. Long-term target for the advance is 7000, but wait for retracement to respect the new support level.

ASX All Ordinaries Index

The ASX 200 closed above 5950 but below its 2015 high of 6000, indicating that small caps are advancing slightly faster than large caps.

ASX 200

The ASX 300 Banks index faces stubborn resistance at 8800. Reversal below the medium-term trendline at 8600 would warn of another test of primary support at 8000. With low capital leverage ratios and Sydney house prices now falling, the sector may be headed for testing times.

ASX 300 Banks

The ASX 300 Metals & Mining index is more bullish, breaking resistance at its three-year high of 3300 to signal another primary advance. I remain cautious because of iron ore weakness and rising Chinese interest rates but retracement that respects the new support level would confirm the advance.

ASX 300 Metals and Mining

The Australian Dollar is falling, iron ore is weak and banks face headwinds but the overall outlook remains (surprisingly) bullish.

Is the ASX over-priced?

On the weekend I discussed how earnings for the S&P 500 have grown by roughly 6.0% over the last three decades but the growth rate should rise as stock buybacks have averaged just over 3.0% a year since 2011. In an ideal world the growth rate would lift to close to 9.0% p.a. if buybacks continue at the present rate. Add a 2.0% dividend yield and we have an expected annual return close to 11.0%.

Forward Price Earnings Ratio for S&P 500

I conducted a similar exercise for the ASX using data supplied by marketindex.com.au.

The first noticeable difference is that earnings for the ASX All Ordinaries Index grew at a slower pace. Earnings since 1980 grew at an average compound annual growth rate of 4.4%, while dividends grew at a much higher rate of 6.3%.

Forward Price Earnings Ratio for S&P 500

How is that possible?

Well the dividend payout ratio increased from the low forties to the high seventies. An average of just over 60%.

With a current payout ratio of 77% (Feb 2017), there is little room to increase the payout ratio any further. I expect dividend growth to match earnings growth (4.4% p.a.) for the foreseeable future.

Buybacks are not a major feature on the ASX, where investors favor dividends because of the franking credits. The dividend yield is higher, at just over 4.0%, for the same reason.

So the expected average return on the All Ordinaries Index should be no higher than 8.4% p.a. (the sum of dividend yield and expected growth) compared to an expected return of close to 11.0% for the S&P 500. That is, if buybacks are effective in lifting the earnings growth rate.

Obviously one has to factor in expected changes in the (AUDUSD) exchange rate, but that is a substantial difference for offshore investors. Local investors are also taking into account franking credits which benefit could amount to an additional 1.4% p.a.. But that still leaves a grossed-up return just shy of 10 percent (9.8% p.a.).

I would have expected a larger risk premium for a smaller exchange with strong commodity exposure.