MEDIA RELEASE: Australia is unlikely to enter a recession, according to Maple-Brown Abbott’s head of Australian value equities Dougal Maple-Brown, although Europe and the US may have already entered one.

“The fall in global equity markets so far has largely been caused by a price-to-earnings (P/E) de-rating. Effectively interest rates have gone up, market multiples have come down but earnings have not moved very much at all in most markets,” says Mr Maple-Brown.

“As we all know, the RBA has been tightening now for most of this year. Everyone keeps saying it's unprecedented but it's actually not.”

He pointed out that the current interest rate tightening cycle is not dissimilar to what happened in 1994. During late 1994 interest rates rose by 2.75 percentage points over the course of five months, rising by a whole percentage point in both October 1994 and December 1994.

“The economy didn't go backwards in 1994. Markets admittedly did. But the rate cycle is not unprecedented, and it doesn't guarantee a recession,” Mr Maple-Brown said.

Mr Maple-Brown says history can provide a good guide for what to expect in a bear market. Looking at the past 40 years, during a bear market, on average, the Australian equity market fell by about a third, it lasted for about one year and experienced approximately a 4-point fall in P/E.

“We're not overly bearish because you’ve got to remember what's already in the price. And we're a long way through this current episode. It's been going for almost a year and the market has de-rated quite substantially,” Mr Maple-Brown said.

The Australian market is currently trading at a forward price-to-earnings ratio of about 13 to 14 times. That is approximately 10 per cent below the long-term average.

However, he also cautioned against reading too much into the market P/E averages which currently hide a wide dispersion between sectors.

Drilling down into the sectors or ‘buckets’ making up the market, a slightly different picture emerges of relatively expensive sectors and others trading on much lower multiples.

Industrials, for example, which make up close to half the Australian market, are currently trading at forward P/E multiples of 21 times earnings and while that has come off highs of 32 times forward earnings, it is still 20 per cent higher than the 20-year average.

“There are many stocks in that industrial bucket, which we consider to be still pretty expensive,” Mr Maple-Brown said.

“We think one of the priciest of the lot is CSL which still trades on over 30x, albeit down from over 40x at the peak.”

When it comes to the financial sector and the banks, there are some interesting anomalies. CBA trades at approximately 2.4 times book value, whereas NAB is trading around 1.6 times and ANZ and Westpac are a little over book value.

“That's a massive difference for businesses which, frankly, aren't that dissimilar these days,” Mr Maple-Brown says.

“Banks are interesting because they should do well in the short term from rising interest rates if the economy manages to avoid a recession but will obviously struggle if the economy enters a deep recession and mortgage defaults rise materially.

“The issue for the banks is the bulk of the fixed rate mortgages roll off in the second quarter of next year. That will be a tough ingestion for the economy as a whole."

Finally, the resources sector is trading on high single-digit multiples, as commodity prices are generally higher than average and Mr Maple-Brown believes investors are wisely not wishing to capitalise these earnings at elevated multiples.

“We remain overweight energy where the lack of investment is likely to prolong the cycle exacerbated by the war in Ukraine. Historically commodities, and resource stocks, have also proved to be a good inflation hedge.”

After a decade of growth managers outperforming value managers, the last two years have seen a turnaround.

“Market conditions should continue to support value managers who can seek out the best performers in the right sectors and we are optimistic there is further outperformance to come,” Mr Maple-Brown says.