As everyone with even a vague interest in the share market would probably know, Australian shares are pretty close to record highs. If we take the S&P/ASX 200 (INDEXASX: XJO) benchmark, it is currently sitting at 7,103 points at the time of writing. That’s only an iota off the record high we saw set on January 22 of around 7,132 points.
These things quickly become ‘the new normal’, but it’s worth noting that we only saw the pre-GFC high watermark fall late last year. That’s eleven long years investors had to wait.
But now we’ve broken fresh ASX ground, we can beg the question of how much further the markets have to run.
Well, unfortunately, no one really knows this.
But we can always guess based on the data we have available.
Why the ASX 200 has more room to grow
There are two things that make the stock market ‘go up’. One is how much money the companies in said market make (earnings). The other is how much investors are willing to pay for that money (price).
That’s why the most common way to actually value markets is by using what’s known as the price-to-earnings ratio (usually just called the P/E ratio), where a stock’s share price is divided by how much earnings per share a company generates. If a share price goes up without the company reporting increased earnings, the P/E ratio rises.
So right now, the ASX 200 has an average and weighted P/E ratio of 19.06 – going off a market-tracking index fund like iShares Core S&P/ASX 200 ETF (ASX: IOZ).
If we take a look at a broader index like the S&P/ASX 300 (INDEXASX: XKO) – represented here by the Vanguard Australian Shares Index ETF (ASX: VAS), we get an average P/E of 18.34 at the current time.
That’s a little pricey, considering the long-term average is around 15, but it’s not overly concerning, let alone in ‘bubble territory’.
But I’d also like to hop across the Pacific to the US markets for a moment.
Right now, the S&P 500 index (which tracks the 500 largest American companies) has an average weighted P/E ratio of 23.66 (I’m using the iShares S&P 500 ETF (ASX: IVV) as a reference here).
That’s a little higher. But it also implies to me that the ASX as a whole has some room to move upwards and follow our American friends higher. There are factors in the US that don’t apply to the Aussie markets that are helping this higher P/E stateside. Not having four big (somewhat under siege) banks in the top six companies does help. But all in all, I wouldn’t be too surprised if we see the ASX rise higher from here.
The hunt for yield could push our market up further in a ‘keeping up with the Joneses’-style race to more closely match the price of the S&P 500 going forward.
There are few alternatives to shares if you want a decent return on your cash these days after all, and this simple fact could be decisive in how the markets do in 2020.
Just a thought!
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Motley Fool contributor Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.