Australian stocks remain cheap relative to other assets

Aussie equities are relatively cheap against a broad range of markets — bonds, foreign equities, gold and property.

ASX, Australian Stock Exchange electronic stock board.

If you’re of the view that central bank pump-priming is driving up the value of all assets, and fundamentals are of less relevance, it’s very clear that Australian equities have missed the boat.

Indeed Aussie equities are relatively cheap against a broad range of markets — bonds, foreign equities, gold and property.

There are a number of implications. First, and for those concerned that a rate hike by the US Federal Reserve might lead to a sizeable equity correction, the Australian market should be more insulated. Not immune from any correction, just insulated, for the simple reason that our market has seen less support.

On a medium-term view the implications for the market are even better. At some point, this comparative cheapness will attract investors. There are many uncertainties hanging over the Australian market at the moment, sure, from the commodity price outlook to the threat of excessive regulation that hangs over our banking sector — to name but two. Yet at some point these concerns will abate. At that point, and it may not be far away, the comparative attractiveness of our market will stand out.

Investors live in a world of prolific currency debasement — where money or currency is no longer acting as a good store of value. So how is an investor to ascribe value to anything?

On traditional metrics most assets are already at, or close to, record prices, measured in monetary terms. Yet what information content does that hold? Not a great deal, because everything is expensive.

This is exactly what we should expect in a world of ultra-cheap money. So to say earnings multiples are stretched, or price-to-book values are elevated, etc, has less meaning. Indeed the general point that equities, bonds and residential property are expensive is meaningless, when what we value it against (money) is so cheap.

Relative value — where investors think of assets themselves as currency — becomes so much more important. Especially when the world’s major central banks are unlikely to end this ultra-low interest rate state anytime soon — even after the Fed hikes.

So investors already know that when it comes to bonds Australian stocks are extremely cheap. Then, again, so is nearly any stockmarket compared with its domestic bond market. So on a bond yield/earnings yield basis (the ratio of the 10-year government bond to the market earnings yield), the Australian stockmarket is at its cheapest in 15 years. In that sense, bonds have been a good store of value, yet we know logically that this isn’t the case as bond prices simply reflect arbitrary central banks purchases.

Another way of making this comparison to a broader group of assets is to simply deflate the price of one asset by another. This method is simple and it has its flaws, yet it does give some indication as to the relative richness or cheapness at a given point in time. Compared with gold, for instance, Australian stocks (MSCI index in US dollar terms) are currently trading at a 53 per cent discount (to gold) compared to pre-GFC levels.

Indeed you have to go back to the late 1980s to mid-90s before you see levels like this held for any reasonable period. Admittedly stocks don’t look so cheap on a longer-time period, but even then stocks are trading at a 10 per cent discount compared to the average ratio since the 80s.

Thought of another way — an ounce of gold buys more Australian shares today than it didn’t before the GFC. A lot more. It’s the same when you compare Australian stocks to the US equity market (MSCI index).

Currently, our market is the cheapest it’s been in about a decade — Aussie stocks are trading at a 14 per cent discount compared to the pre-GFC average. Thinking of US stocks as a currency, they buy more Aussie equities than at any time over the last decade.

Now there could be fundamental reasons for that — stronger earnings, for instance, or faster economic growth. That isn’t the case though, and even comparing relative price to earnings ratios, the outcome is the same. Nor is it the case that post-GFC nominal growth has been faster in the US — and yet US equities are better currency.

What’s more interesting is that viewed over a longer time horizon (say since the 80s), Australian stocks are even cheaper — at a 32 per cent discount. It’s a similar situation comparing Aussie equities to those in the emerging markets or Germany. Only against the British market could Australian stocks be said to be comparatively rich.

What about property? Well, for all the talk of a housing bubble, stocks don’t look especially cheap in comparison. Maybe at a discount of 6 per cent or so over the last decade, although that leaves stocks 25 per cent cheaper compared to the few years immediately before the GFC. In that sense property has still been a better currency — a better store of value — although, again, there are few fundamental reasons to think that should be the case.

Aussie stocks are cheap, very cheap with respect to many other assets. In an ultra-low-rate world, we shouldn’t expect that discrepancy to hold for long.