1. Has the All Ordinaries Index “hit bottom”?
2. What is its “fair value”?
I believe neither that it’s hit bottom nor that it’s close to a bottom. The course of its descent to – and the level of – its eventual nadir depend partly upon the extent to which the AOI’s earnings fall; and that, in turn, hinges partly upon the severity of the recession. Earnings peaked in October 2008 at $489, and by March 2009 had shrunk to $365. If they revert to their long-term trend, then ca. 40% of this distance has been traversed. Of course, just as observations “overshoot” above a trend, they can also “undershoot” below it.
Given how we came to this pass, where Australia now stands, what the government is doing to us and what may lie before us, it’s difficult to conclude that stocks are cheap and easy to believe that they remain dear. True, the AOI is less overvalued now than it was, but “less overvalued” is not the same as “undervalued.”
Accordingly, Leithner & Co.’s plans include the possibility that an environment marked by recession and stagflation (like the one that plagued the early 1970s to the mid-1980s) prevails during the next several years.
In such a climate, the fair value of the All Ordinaries Index would be ca. 1,700-2,300. That implies a fall of ca. 70% from the Great Bubble’s maximum and the harshest bear market in Australian history. Furthermore, taking 2,000 as the AOI’s “bottom” and assuming a long-run growth rate of 7.5% per annum, ca. 17.5 years will pass before the Index returns to its Bubble maximum of ca. 6,850. If so, this will be the most fraught recovery in Australian history.[/QUOTE]