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When & how to switch from Growth to Value stocks
The ASX200 continues to struggle around the 5600 area, unfortunately it’s not even managed to regain 50% of its coronavirus losses yet some stocks / sectors have almost shrugged off the pandemic as if it didn’t occur. The Australian IT sector is only 11% below its February all-time high while the Healthcare Sector got within 6.2% of its equivalent milestone in April, conversely the Banking Sector is still over 40% below its 2020 high and I won’t even do the maths on the decline from its high in 2015. When I dive deeper under-the-hood we see 24 members of our index down over 40% in the last 3-months whereas an almost equal number (22) are actually up, clearly illustrating that performance in 2020 has more than ever depended on what horses you’ve backed.
Not surprisingly, the stocks which have revelled in the coronavirus uncertainty, on both the economic and social fronts, has been dominated by the Gold Sector but the IT stocks have also enjoyed the environment with about half of its members trading higher. For some the pandemic has actually created a tailwind for earnings which combined with huge central bank liquidity and interest rates plunging to around zero has created enormous support in certain areas of the market. MM remains bullish equities medium-term with the major driver still liquidity, the Fed is not somebody to pick a fight with:
“Unlimited QE & emergency liquidity programs should see the Fed balance sheet double in size over 2020” – note the word unlimited, until they’re comfortable the virus is under control they look highly likely to support assets when / if required.
Our short-term outlook on an index level for the last few months hasn’t wavered – “sell strength and buy weakness’”. However while this has been on the money it doesn’t vaguely tell the whole story of the ASX’s performance since the panic sell-off in March. Today we will quickly reflect on what we’ve seen to-date while more importantly focusing on where MM believes investors would be focused for the next year, or two. Remember an important line from a few of our recent reports:
“if we are correct some of the best gains will be seen in the currently less popular Value Sector but it still feels a touch too early to flock towards the view.”
Firstly, Let’s consider a couple of major MM macro views for the years ahead:
1 – Official interest rates will remain very low for the foreseeable future but we believe longer dated bond yields have bottomed e.g. US & German 30-years at 0.7% and minus -0.56% respectively i.e. we believe the cost of money is set to rise, albeit off an extremely low base.
2 – Inflation will raise its dangerous head in the quarters ahead as the enormous liquidity global central banks are pumping into circulation starts filtering through into the global economy.
3 – With central banks effectively already “all-in” with Monetary Stimulus it’s the time for governments to step up with a likely unprecedented fiscal effort.
The combination of these 3 economic scenarios with good old fashioned valuation comparison’s brings MM to the conclusion that its time to consider if / when good old fashioned value stocks can regain some of their mojo, after all the likes of AfterPay (APT), Appen (APX) and CSL Ltd (CSL) must by definition become overpriced at some point in time.
US 30-year Bond Yield Chart
Value Index / Stocks
Firstly, let’s consider what value stocks actually are:
Value stocks: “A value stock is one which trades at a lower price relative to its fundamentals including dividends, earnings and sales.”
Traditional value stocks / sectors: Retail, Banks, Industrials and Resources but if Apple were to find itself cheap enough it would fall under the same umbrella but stocks with growth rarely become “cheap enough”.
Warren Buffett is arguably the most famous value Investor with one of his regularly regurgitated quotes summing up his outlook – “Price is what you pay, value is what you get”. Buffett’s long-term performance has been very impressive but he’s clearly struggled in 2020 as markets have poured into growth / IT stocks although there are by definition a lot of moving parts when you get as big as his investment vehicle Berkshire Hathaway (BRK/S US) which is currently sitting on almost $US140bn in cash!
NB AS we mentioned above a stock like Apple (AAPL US) can in theory have a foot in both camps if it trades low enough.
US S&P500 Index v Berkshire Hathaway (BRK/S B) Chart
When we look at the US Value Index on a stand-alone basis the picture its very constructive, although it still remains over 20% below its all-time high. The market just endured a news driven sharp correction but buying rapidly emerged into weakness leaving us bullish looking for ~40% upside, targeting fresh highs in the next few years - it may not reach the milestone in 2020 but we believe there’s a very good chance by 2021.
NB We are only using US markets because they are more readily available than the Australian equivalent.
US Value Index Chart
The below chart is a quick glance at 3 of the major sectors in the value corner of the ASX, the cynical reader might call them “The 3 Ugly Ducklings” when compared to the IT sector. The Resources Sector for example could also have been included but it would have simply made it all look too messy – the clear standout is the relatively small corrections after their coronavirus caused plunge in March – the Australian value stocks in the main have recovered less than their US peers.
However MM took a quick 50% profit on Santos (STO) last week illustrating that with some optimum timing pockets of the value sector have delivered great returns to the nimble, below are some great performances that have caught our attention in both the large and small cap end of town following the March sell-off:
Small Caps: Emeco Holdings (EHL) +122% and Pact Group (PGH) +76%.
Medium Caps: OZ Minerals (OZL) +69%, NRW Holdings (NWH) +132% and Beach Petroleum (BPT) +79%.
Large Caps: BHP Group (BHP) +46% and Fortescue Metals (FMG) +72%.
Note the distinct lack of banks from the list, waiting for Australia’s largest sector to bounce has felt like a kid waiting for Christmas. However never say never, especially if bond yields creep higher and bad debts don’t reach the markets current expectations – we are confident “the market” is very underweight Australian banks hence when they turn it will be explosive, we’re watching carefully for a catalyst.
If stocks correct part of their significant recovery from the March lows we will be looking to accumulate the top performers of the last few months, conversely if we continue to grind higher through 2020 it’s a tougher game and we have to look for the next “good thing”. While we always remain open-minded and flexible the first scenario is our slight preference.
ASX Energy, Banking & Industrials Indices Chart
Growth Index / Stocks
Now let’s turn our attention to growth stocks:
Growth stocks: “A growth stock is traditionally one which grows earnings well above the market average paying a low / no dividend as it would rather re-invest profits to accelerate growth. These shares usually trade on elevated valuations.
Traditional value stocks / sectors: Locally IT and Healthcare sectors dominate this space.
The US Growth Index has rallied around four-fold post the GFC as the world embraces technology at an ever-increasing rate, the coronavirus pandemic has accelerated the new world order as the likes of Zoom meeting become de rigueur. This group of stocks, which is dominated by the FANGS is only 7% below its all-time high and a breach in 2020 feels inevitable, although we must question what degree of optimism is already built into the likes of Amazon (AMZN US) and Netflix (NFLX US).
US Growth Index Chart
Below is a quick glance at the main 2 players in the local growth sector plus the Resources (Materials) Index which we deliberately omitted from the equivalent graph in the value section earlier. A couple of points of interest caught my attention:
1 -There are early signs that money has already started flowing out of the Healthcare Sector, this makes sense as the COVID-19 outbreak caused panic buying in some of its stocks, potentially creating a multi-year out-performance high.
2 – The IT Sector remains strong and looks destined to make fresh all-time highs.
3 – The Resources Sector looks to have turned and is keeping pace with the high flying IT Sector.
Within the growth sector MM now primarily has interest in the IT Sector.
ASX Healthcare, IT and Materials Indices Chart
Comparison of Growth & Value Indices
The really dramatic picture unfolds when we compare the performance of these two indexes since the GFC, its basically been a one horse race with the growth stocks trumping their value peers with only one standout contrarian period – in Q4 of 2018 when financial markets became very concerned that the US Fed would raise interest rates too fast and subsequently plunge the US into a recession, we saw the high valuation stocks across the world get smacked far harder than the underlying index e.g. CSL Ltd (CSL) fell over 25% in a couple of months.
Today we find ourselves in a huge global recession that could even evolve into a depression. if we experience a major second / third wave outbreak of COVID-19, but growth stocks keep trundling higher which in our opinion is fuelled by all-time low bond yields and of course in a number of cases the new world order embracing their businesses / products. If we are correct and bond yields have bottomed the huge performance differential is under threat, especially as a number of these stocks are trading on huge valuations.
MM believes rising bond yields is slowly becoming a worry for high valuation / momentum stocks, similar to Q4 of 2018.
Picking the ideal time to switch from growth to value is a tough ask especially as the momentum is clearly entrenched but by definition, as we saw in 2018, when the rotation does commence it will be fast and dramatic because the market is clearly positioned very much in one direction - a bit like a large game of musical chairs but when the music stops playing someone’s removed way too many chairs! We believe its time to slowly start tweaking portfolios towards value as opposed to being caught in the panic, a bit like Baron Rothschild would have been planning:
“I will tell you my secret if you wish. It is this: I never buy at the bottom and I always sell too soon.” – Baron Rothschild.
The next question is what stocks / sector should we be considering.
Our conclusion from early analysis is its time to be accumulating resources , including energy, stocks but not yet the bank’s.
US Growth & Value Indices Chart
Lastly, when we take a quick glance at the US broad based Russell 3000 Index a 5-10% correction, to the strong rally from March’s low, would not surprise. If this does unfold, we would be targeting the IT sector plus best performing value stocks of the last month, a couple were touched on earlier.
US Russell 3000 Index Chart
If stocks continue to grind higher under the weight of liquidity driven buying, we advocate looking for new opportunities amongst the value stocks.
If equities do experience a correction in June / July we would be targeting the best performing IT and value stocks into weakness, simply those which have rallied the most since late March.
At this stage we have no catalyst to increase exposure to Australian Banks.
Our positions as of Friday. All past activity can also be viewed on the website through this link.
Weekend Chart Pack
The weekend report includes a vast number of charts covering both domestic and international markets, including stock, indices, interest rates, currencies, sectors and more. This is the engine room of our weekend analysis. We encourage subscribers to utilise this resource which is available by clicking below.
Have a great day!
James & the Market Matters Team
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