With the asset prices of residential housing out of control, what about other asset classes such as stocks? Are they overvalued as well?

As mentioned, the wealth effect stemming from over inflated house prices, cheap and easily available debt and high consumer confidence has helped to drive the economy or if anything, overdrive the economy. The effects of this have been seen in the Australian Stock Market.

Double digit growth has been the norm for the last three financial years, with the ASX 200 index doubling in four short years from April 2003 to April 2007. Prior to April 2003, it took 11 years for the ASX 200 index to double. The solid growth has seen just about everyone have a flutter, as it is almost impossible to lose money in this present environment. Lets just hope, investors don’t get too complacent.

ASX Share Indices.

But unlike housing which has defied basic fundamentals, is the ASX overvalued? The Price Earnings (PE) ratio is normally a good gauge of the value of shares. The share price should be approximately 15x EPS (earnings per share).

From the table below showing historic PE ratios, while the ASX has been surging along, if anything the stock market is getting cheaper and more value for money. This has been due to excellent earnings results of companies, and in some cases, companies so flushed with cash they are doing share buybacks.

Average PE ratio for ASX-200 listed companies.

The only real downside risk to shares is if earnings were to fall. This would happen if the global consumer runs out of money (or loses their job), or if consumer confidence was dented, caused possibly by a housing asset crash and the associated wealth effect phenomenon. Hold on to your hat – It’s long way down.