Australian equities are currently undervalued and price-to-earnings multiples will climb dramatically, but institutional investors should be ramping up their exposure to shares even as prices rise.
This is the view of Hostplus CIO, Sam Sicilia, who predicts inflation is unlikely due to ongoing technology forces and Australia faces an extended period of low growth and lower corporate profits.
Sicilia’s comments came as the Reserve Bank of Australia cut its near-term inflation forecasts to 1.7 per cent this year, from its previously forecast 2 per cent, and to 2 per cent in 2020 from 2.25 per cent.
According to the CIO of the $43 billion superannuation fund, by slashing its inflation expectations the RBA recognises there must be downward pressure on inflation.
Worse, he warns, the RBA then went on to say that it expects inflation to increase to 2.0 per cent in 2020.
“How does the RBA think inflation will increase from 1.7 per cent in 2019 to 2.0 per cent in 2020?
“The RBA is unrealistically, in my view hoping the world goes back to the old normal.
“We are not returning to that normal world where we can create inflation,” he said, citing the sweeping changes disruption has brought.”
Pointedly, the RBA noted in its recently-released statement of monetary policy that strong employment growth over the past year has led to some pick-up in wages growth. The central bank called it “a welcome development”.
However, this is inconsistent with Sicilia’s view that employment growth may happen over the short term but full-time equivalent unemployment numbers will start to increase as technology continues to replace some of the functions that people are currently employed in.
“We will also need fewer people to do the same some jobs,” he adds.
While there are forces pushing inflation up, Sicilia is convinced there are bigger forces pushing inflation down.
He argues there are two forces at play. Technology which is massively deflationary and the fear of job loss. Both will stifle wage inflation or price inflation.
Further, according to the CIO, since people will fear job loss due to ongoing technology trends, it is unreasonable to expect them to ask for wage rises.
“People are not asking for wage increases because there is no price inflation. If there was people would be screaming for higher wages,” he adds.
“Therefore, the RBA is talking up their hope that there will be wage inflation but this is unlikely to happen. And even if some additional wage growth was granted, people need to spend it big-time in order to generate inflation.”
Taking aim at central banks
Sicilia is not just taking aim at Australia’s central bank, but central bankers around the world for trying to use monetary policy to control inflation.
When inflation is too low they typically use rate cuts to increase inflation.
“It follows that the RBA and the central banks around the world are wasting their time with interest rate rises or cuts because they’re not going to be able to generate inflation,” Sicilia cautions.
“Further, any central bank that tries to go back to normality by hiking rates will get whacked by the equity markets which is exactly what happened when the US Federal Reserve tried to normalise last December.
“Once the Fed changed its mind and held rates steady, the markets roared. In the space of two months, equity markets went from the worse December ever to the best January.”
Of course, Sicilia admits he could be wrong. He accepts that he and his team could be putting too much weight on the wrong pressure.
He lists the forces at play in societies – productivity forces, supply and demand forces, trade imbalances, currency wars as well as cultural impacts.
But as he sees it, the single force at play everywhere is technology.
Sicilia is looking at annual returns of 4 per cent from Australian equity investments in a low growth, low earnings environment.
“In a low growth world, let’s say the absolute most you can get from an asset class is 4 per cent,” he calculates.
“Further, if you thought it was going to be a low growth world for a very long time, then wouldn’t you be prepared to pay more for any company with any forward earnings prospect to try and secure the maximum 4 per cent that’s available?
“Then it follows that equities are currently very, very cheap.
He concludes that investors will pay more for scarce company earnings and ASX P/E multiples may end up being more than 30 times.
That’s his point.
Currently, the ASX equity market P/E multiple is around 16 times.
As multiples move from 16 times, to 23 times to 25 times, he goes on to say, the market will look increasingly expensive.
But with each increase, he noted, past P/E multiples will seem cheap in comparison.
Hostplus has 53 per cent of its assets allocated to equities with zero asset allocation to cash and bonds.
To Sicilia, bonds don’t even rate as a risk management tool any more. “They’re not doing the job. People who are buying bonds for downside protection are wasting their time.”