The recent Reserve Bank of Australia (RBA) decision to keep interest rates on hold is well supported by the charts below.

House prices and household debt are parasailing at 500% and 200% respectively of disposable household income. This suggests a fair amount of household stress at the minute. Personal bankruptcies in Australia are up, but that's a separate topic.

On top of that, wages appear to be growing at a very low ~2%.....

...and most of that growth is being eaten away by inflation, however insipid.

Despite price declines in some housing markets, there has been insufficient real wage growth to bolster household incomes, which is why the lines in the first chart continue up to the right. 

To improve on bank deposit rates which for many represent a negative real return, many investors remain in riskier asset classes such as equities, bonds and other alternative investments/speculations.

It is the same in Europe, the UK and the US (although metrics differ somewhat across the globe) and it explains why there is still an excess of rocket fuel in equity/bond markets.

Many companies have spent the last 6 or 7 years tapping these relatively free and easy markets to accelerate organic growth plans, takeovers and share buy-backs - all leading to higher valuations. The cheap money party was taken to a new level recently after the passing of the US tax cuts last year. 

The cumulative result has been serious amounts of equity and debt rocket fuel pumped into companies to accelerate earnings and share prices. Ordinarily, that is, in the absence of quantitative easing, this growth would have been funded in a more pedestrian manner and at a more normal/higher cost of capital.

It therefore makes sense that if these northern hemisphere excesses disappear in the course of central bank balance sheet/interest rate normalisations, corporate earnings expectations would need to recalibrate. Lower earnings expectations matched with long-run average price to earnings ratios (lower than what we see today) would paint a very different picture. 

While there have been some jitters of late, the question as always is timing and the extent to which Governments and Central Bankers intervene, rightly or wrongly.

Mike

NextLevelCorporate delivers independent and transformative corporate finance solutions to clients looking to reshape their competitive landscapes, in and out of Australia. Our ability to do this comes from ~30 years of sector-specific proprietary intel and the freedom to independently originate and advise on customised Mergers and Acquisitions, Growth Capital and Special Situation solutions.

You can subscribe to our newsletter here.