At what level does the ASX 200 become 'very expensive'?

On the current analyst consensus numbers, we can see the ASX 200 trading on 16.1 time’s forward earnings, which is 6% above the five-year average of 15.2x.  However, this is still below the 17x forward multiple investors were paying in Q2 2015 and mid-2016. So the market is pricey, but not at a level where the fund managers really start getting hot under the collar, going to cash or looking at hedging structures. That comes when the index trades on a multiple of 17x and into 17.5x.

We can also see the consensus forecasts for earnings-per-share (EPS) have been revised higher, consistently since mid-2016 and now sit at 361c. A rise of around 20% in that time. However, what is going to propel earnings higher from here is now the key question, given a lot of the EPS revisions have come from higher oil, bulks and base metals.

Global growth is looking a touch better, but I’d be surprised if we saw it higher than 3.3% in 2017. ‘Trumponomics’ is looking shaky and most expect this to be a late 2018 story, if at all. US corporate tax reform is being slated for August and if it can go through successfully, it would be a positive for the S&P 500 (and specifically the Russell). However, I can’t see how it will be positive for Aussie corporate earnings. US tax reform is good for sentiment in risk assets more broadly, so this would be good for price expansion in the ASX 200. Given the technical break of 5830, we can feasibly look at 6,000 as a target.

However, while the prospect of 6,000 will be welcomed by many, I am sceptical the ‘E’ side of the P/E equation pushes higher from here. A move into 6,000 should see the ASX 200 pushing above 17x – a level the market has shown they just aren’t comfortably paying for those future earnings and cash flows.

All we would need is some macro concerns and the index will be highly vulnerable to a much greater sell-off and shorting opportunities will be far more abundant. 6,000 will offer some great shorting opportunities for traders as the market will be expensive, so one for the radar should it get there.