The ASX is due a fallow year: Here are 3 reasons it could be FY26

If you read my piece this morning on why a lack of euphoria doesn't mean we won't see a stock market crash soon, it may come as no surprise that I'm now fairly bearish on the outlook for equities.

History tells us that all good things come to an end, and the bull market we've enjoyed since 2022 (and more broadly since the Covid crash of March 2020) must run out of steam at some point. 

Is the ASX 200's green run about to come to an end? 

We've now had three consecutive financial years of strong equity price growth, despite earnings growth being negative for two years in a row. 

But looking back since 2000, these green runs have never lasted more than three financial years in a row and are often punctuated by a noticeably-red year. 

Even the golden equities run in the decade following the GFC saw negative total returns for the ASX 200 in both FY2012 and FY2016.

Of course, measuring stock market performance by financial years may seem arbitrary. 

I would argue it's less arbitrary than measuring by calendar year, given how companies measure and structure their own performance and reporting around the financial year.

Here are three big reasons while FY26 could be one to forget for the ASX:

1. P/E Ratio

This is unlikely to be the first time you've seen someone raise this point, but it bears repeating:

The ASX 200's P/E ratio remains unusually elevated above its historic average. 

The biggest issue here is that the Australian stock market isn't built on hyper-growth-focused companies that can justify outsized valuations with the promise of future earnings.

The Commonwealth Bank (ASX: CBA) is the perfect case in point. 

As Atlas Funds Management's Hugh Dive wrote back in June, CBA was "the first developed market bank in history to trade at a multiple greater than 30 times earnings". 

While it has since receded from those lofty heights, its valuation remains hard to justify from a growth and ROE-perspective. 

It's symptomatic of a stock market abandoning any sense of fundamental value. 

2. Earnings yield

Market-cap weighted earnings yield for the All Ords is hovering well below its historical average.

If we take out the period around the Covid pandemic, where earnings were understandably crushed, it's effectively the lowest it has been in more than 50 years.  

Coupled with an elevated P/E ratio, this doesn't suggest a stock market in rude health.

3. Inflation

As I mentioned in my previous article, Australian headline CPI inflation was back up to 2.8% in July, from a June reading of 1.9%. 

That is at the upper end of the RBA's target range of 2-3% and suggests the years-long fight against post-Covid inflation is far from over.

And the current problem for the ASX is that it seems investors are already pricing in the expectation of the RBA cutting rates further over the next year. 

Despite their cautious approach to rate cuts (which itself has attracted widespread criticism), Damien Boey from Wilson Asset Management recently argued that the "RBA is already running the cash rate below levels suggested by credible policy rules."

It risks upsetting the bond markets if it continues to cut rates, or upsetting stock investors if it puts the brakes on. Both could be bad news for those expecting the ASX to keep rising. 

By some of its key metrics, the ASX is overvalued and underperforming at a time when the wider economic picture isn't as rosy as many seem to think. 

If the good times are coming to an end, you'll know why.