There is a growing divergence between valuations and fundamentals, contributing to “crazy” ratios and a growing tendency towards momentum-driven investing, according to Schroders’ head of Australian equities Martin Conlon.

Conlon noted that the intense focus on technology was particularly surprising in the last reporting season. In particular, he highlighted the “ludicrous” scale of investor reactions to what were in most cases “very small” earnings surprises, as demonstrated by WiseTech Global in the Australian market.

In a recent webinar, Conlon explained that while WiseTech Global’s revenue increased by $250 million and profits rose from $300 million to $380 million — largely due to acquisitions — along with $60 million more in capitalized R&D, the market cap has raised more than $9 billion, which he stressed was “bigger than most companies in Australia, not to mention a price move”.

Notably, the stock jumped 17% on the day of the earnings report, driven by surging earnings and growth prospects, and as of Sept. 9, it is up more than 60% for the year to date.

Such optimism demonstrates how the tech sector's rapid rise has led to "pretty crazy" price-to-earnings ratios, Conlon explained.

“I think we all know [tech is] at the epicenter of speculative activity around the world, the Nvidias of the world in the US. That's where prices can move the most, and people are attracted to the prices that move the most because they like the quick money,” he said.

Conlon noted that while the ASX is relatively expensive compared to other markets globally, widespread enthusiasm for growth, particularly in markets such as the US and India, is driving valuations higher as investors flock to growth opportunities.

"People run to where there is growth. Markets like India, [they’re] very expensive because it's growing,” Conlon said.

"Mention growth and investors get excited."

However, with fundamentals seemingly taking a backseat to growth, the investment executive noted the need for caution.

"It worries me how many fundamental investors look at these reactions and then assimilate that behavior so that they almost lose sight of the fundamentals and become momentum investors themselves," he said.

"I think this is one of the most dangerous trends in equity markets."

Promising areas

Conlon noted that while markets are generally expensive, most of the increased valuations are concentrated in a few sectors such as IT, leaving room for opportunities in less inflated areas.

“I think it's very hard to argue that anywhere looks cheap relative to interest rates, so market prices and asset values ​​in the property and equity markets remain quite expensive compared to history. But if you dig below the surface, most of the expensive market is really driven by a few sectors with very high prices. IT remains the core,” he said.

For investors happy to expand beyond this narrow rally, Conlon recommended areas such as resources, materials and energy trading at "very normal multiples."

Also taking part in the webinar, Justin Halliwell, head of research at Schroders, said the mining results were remarkable.

"One thing that struck me about the results in the mining space is that earnings have remained stable, both at the price level and at the cost level, which is unusual especially in the big end of town," Halliwell said.

Also, while steel companies face shrinking margins as China's steel exports near a record 100 million tonnes, he believes most investors are missing the long-term opportunity.

"While logic suggests that supply will decrease and margins will recover, the time frame for logic to prevail is often longer than expected," Halliwell said.

"Companies with strong balance sheets and a strong cost position will be well positioned to enjoy the inevitable improvement."