The return of the spectre of trade war between the US and China has rattled markets trading at record highs. Should investors buy the dip, or prepare for pain?
A months-long rally in companies that have never turned a profit. An artificial intelligence investing bonanza that has reshaped markets. And all in the midst of the most turbulent period in global politics in decades.
With Wall Street smashed on Friday, and the ASX set to follow on Monday, investors are faced with a critical decision: do they interpret the plunge as just another blip in a bull market, or the start of something far worse?
US President Donald Trump’s threat of huge tariffs on China hammered stocks in a reminder of just how thin the margin for error is in equity markets that have been trading near record levels.
The euphoria surrounding AI and optimism about interest rate cuts has pushed equity valuations to historically high levels and unleashed a blistering rally in speculative assets such as bitcoin and profitless stocks. Naturally, those sectors were the hardest hit when the market reversed.
Marko Kolanovic, the former chief equity strategist at JPMorgan who has been tipping a sell-off for some time, said investors should prepare for more “systemic” selling when trade resumes on Wall Street this week.
While some fund managers have already started slashing exposure to the hottest pockets of the sharemarket amid concerns of a bubble, others believe the wild gains in technology stocks are justified and any correction could be an opportunity to buy the dip. “We have barely scratched the surface of this 4th Industrial Revolution now playing out around the world,” wrote Wedbush Securities’ Dan Ives, an influential Wall Street analyst.
The Australian Financial Review asked some of the country’s top fund managers where they thought the market was headed.
Jacob Mitchell, Antipodes Partners
In the US, equities now reflect a near-perfect landing – slowing inflation, policy easing ahead, and AI revolution that delivers productivity without dislocation. The problem is that the macro scaffolding hasn’t changed: consumption still leans on fiscal transfers, credit quality is softening, and monetary policy has lost much of its bite. Where it is assumed nothing goes wrong, US equities are trading at a premium to even their own history.
Within that market, the AI complex has become the new hedge – stocks that supposedly work in any environment and have become the source of a concerningly concentrated market. Yet the build-out phase is still underway while prices already discount the pay-off and where capex investment is being priced as permanent revenue growth. Much of the remainder of the US market outside of technology is overweight expensive quality, priced for resilience that depends on stimulus and sentiment holding firm.
Elsewhere, expectations are lower and cycle less mature. Europe is benefiting from targeted investment and industrial policy revival; Japan’s reforms and wage gains make its recovery sturdier than usual. Even China – weighed down by property and demographics – looks priced for stagnation, meaning the risk-reward there is balanced rather than one-sided.
Matthew Haupt, Wilson Asset Management
Global risk appetite has reached euphoric levels, with the Australian equity market appearing stretched across most valuation measures. On a 12-month forward consensus basis, the ASX is trading near 20 times earnings – well above its long-term average of 14.3 and inconsistent with prevailing inflation expectations and credit spreads. The market’s gross dividend yield of just 3.2 per cent, below the 10-year bond yield of 4.3 per cent, suggests investors are assuming robust earnings growth and continued policy support.
In our view, elevated valuations are being underpinned by the protection of the global financial “plumbing”. Extraordinary policy support and abundant liquidity have kept most asset classes near cycle highs. As long as confidence in this backstop persists, asset prices are likely to remain resilient, with market shocks causing only transient draw-downs.
We monitor the health of this system daily through primary dealer repo activity and global reserve balances. While early signs of strain are emerging, it is too soon to call an end to this liquidity-driven regime.
Armina Rosenberg, Minotaur Capital
It’s too simplistic to say that markets are overvalued – the picture is more nuanced. There’s no question the air is getting thinner at current levels, particularly for some of the mega-caps. Oracle’s recent surge on cloud optimism is a good example of how sentiment can quickly stretch.
There’s also a growing sense of circularity in AI financing. The same “AI kingmakers” are funding and selling to each other, and much of this trillion-dollar build-out is being financed by ballooning debt.
That said, this isn’t a dot-com rerun. Unlike in 2000, there’s real revenue, profits, and cash flow underpinning these businesses.
For investors, the key is to be selective.
We still see earnings momentum, and there’s genuine breadth returning to markets. We find the rest of the world outside the US more attractive with the same exciting thematics, but at more reasonable valuations. With the level of uncertainty both with policy risks and geopolitical tensions, we are liking durable defensives such as select healthcare names and defence, and a strategic allocation to precious metals as policy insurance.
Patrick Hodgens, Firetrail
It’s fair to say the Australian market looks expensive, but stretched valuations are concentrated in a few hot pockets: the major banks, some quality growth names, and Aussie mega caps – the top 10 ASX stocks now making up almost half the ASX200. Outside of that there’s still value to be found, especially in mid and small caps trading at cheaper valuations compared to large caps yet delivering stronger earnings growth.
We’re seeing improving earnings momentum across several areas: insurers with strong pricing tailwinds, select industrials supported by infrastructure spend, and parts of the consumer space, particularly travel, where conditions are stabilising. We also see opportunity in gold, uranium, and copper stocks if underlying commodities stabilise around current levels.
So, while the ASX200 looks stretched on headline metrics, the opportunity set beneath it is broadening. That’s a healthy sign, pointing to a market transitioning from narrow leadership to one where more companies are contributing to growth. The Small Ords Index has already comfortably outperformed the ASX100 over the past quarter.
The other key point is that volatility has picked up at an individual stock level, but less so at an overall index level. Individual stock share prices are swinging more violently on results and outlook changes, which can feel uncomfortable but is great news for active investors. It creates the kind of dispersion where fundamental research and conviction can really pay off.
Daniel Moore, IML
At an aggregate level, the Australian share market appears increasingly stretched on valuation relative to history. A key metric we like to monitor is the equity risk premium, which is the difference between the ASX 200’s earnings yield and the 10-year government bond yield – which quantifies the additional return investors demand for bearing equity risk over safer fixed-income alternatives. Currently, the premium is just 0.5 per cent, near multi-decade lows and well below the long-term average of between 4 per cent and 6 per cent. Such compression helps explain why many dividend yields are well below term deposit rates and why stocks in sectors like banks, technology and retail command multiples unseen in their histories.
While this backdrop does not bode well for forward returns at an aggregate level, it’s far from all doom and gloom: pockets of opportunity persist. Sectors like healthcare and packaging for trade at decade-low multiples.
Phillip Li, SG Hiscock
One always sounds smart playing the bear, but the truth is likely somewhere in-between – valuations are indeed stretched in certain pockets, but there’s limited signs of widespread euphoria.
The ASX remains less exposed to the AI enthusiasm driving US markets, with most businesses still trading on fundamentals rather than narratives. From an economic activity standpoint, fiscal-industrial policy plays an increasing role supporting select businesses with offshore exposures, Europe through defence and energy spend, and of course, the US administration driving onshoring of critical supply chains through government funding and other generous incentives.
Sentiment wise, the frequency of bubble-call headlines indicates a signal of restraint, in that most investors appear cautious, not exuberant. This is evidenced in capital flows, with global funds rotating toward emerging markets as well as Chinese tech, recognising the growth – valuation gap on offer. Likewise, domestic small-cap outperformance through reporting season shows clear recognition that superior earnings growth in the smaller end is more attractive than our more expensive large cap counterparts.
Ross Cameron, Northcape Capital
There are several indicators that the US market looks very bubbly and frothy, you can see that in anything AI related. Currently, there’s been the worst underperformance in quality since 1999, which was the last time we had a massive tech bubble. The fact that non-profitable tech is outperforming profitable tech is a sign of over exuberance in the market.
The question is if the US market rolls over because it’s looks bubbly, whether the other markets that are cheap can hold up, or whether the US will bring everything down with it. Emerging markets still look very cheap.
Qiao Ma, Munro Partners
We remain constructive on equity markets. Supportive US policy, continued AI investment and demand, and a renewed easing cycle from the Federal Reserve, create a favourable backdrop for growth investing.
In addition, we continue to see an increase in broad-based corporate mergers and acquisitions (M&A) and further growth in capital market activity. Policy measures that allow this activity to happen are, in our view, a tailwind for corporate America and something we expect to provide further support for equity markets.
Most importantly, we believe earnings fundamentals remain robust. While valuations sit above long-term averages today, we do not view markets as broadly overvalued. In fact, we’re finding many small and mid-cap opportunities at really attractive valuations. As long-term investors, we remain constructive about future earnings growth and believe that share prices ultimately follow earnings growth in the long run.
Katie Hudson, Yarra Capital Management
The small-cap market, as measured by the S&P/ASX Small Ordinaries Index, is trading at a slight premium to long-run averages but remains 7 per cent below large-cap valuations. This valuation discount comes against a backdrop of materially higher earnings growth. The sector delivered 10 per cent higher earnings in the last financial year, and consensus forecasts suggest this trend is set to accelerate in this financial year.
Higher earnings growth is supported by greater exposure to the Australian economy, with growth beginning to accelerate from a cyclical low point, declining interest costs, increased exposure to higher-growth businesses, and a larger exposure to growth commodities such as gold and copper.
With confidence improving, we are seeing small-cap companies resume M&A and expect a strong pipeline of deals into the end of the year.
Tim Carleton, Auscap Asset Management
In a global context, the Australian equities market is slightly expensive compared to history, but nowhere near as extreme as US equities.
Within the Australian market there are pockets that look very expensive, particularly in the mega cap space. But there are other parts of the market that appear to be reasonable value. The healthcare and real estate sectors are two examples where valuations appear attractive. So we think the current environment is about being selective as to where you are invested.
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