Rudi’s View: Time For Quality To Shine

rudi-views
Always an independent thinker, Rudi has not shied away from making big out-of-consensus predictions that proved accurate later on. When Rio Tinto shares surged above $120 he wrote investors should sell. In mid-2008 he warned investors not to hold on to equities in oil producers. In August 2008 he predicted the largest sell-off in commodities stocks was about to follow. In 2009 he suggested Australian banks were an excellent buy. Between 2011 and 2015 Rudi consistently maintained investors were better off avoiding exposure to commodities and to commodities stocks. Post GFC, he dedicated his research to finding All-Weather Performers. See also "All-Weather Performers" on this website, as well as the Special Reports section.

Rudi's View | Jul 01 2021

In this week's Weekly Insights:

-And Australia's Favourite Sector Is..?
-Rising Equities Are Getting Cheaper
-Time For Quality To Shine
-Gold's Dubious Inflation Claims
-Conviction Calls
-All-Weather Model Portfolio
-Research To Download


By Rudi Filapek-Vandyck, Editor FNArena

And Australia's Favourite Sector Is..?

What if I asked you which sector is the long term favourite among institutional investors in Australia?

Banks? Healthcare? Bulk commodities producers?

The answer will surprise you, as it is Consumer Discretionary.

Analysts at JPMorgan, who run a monthly survey among domestic fund managers and thus have access to a wealth of data, reported last week the Consumer Discretionary sector has been the most persistent Overweight in institutional portfolios in Australia.

Further adding to the sector's favourite status among institutions is the observation the average large Overweight positioning (relative to the actual index weighting) is well, well above the number two, which at present is the Materials sector.

The most convincing argument to prefer one sector over others is always the performance and here, JP Morgan reports, the justification aligns with Consumer Discretionary markedly outperforming the ASX200 over the past five years.

When I mention Consumer Discretionary most readers are probably thinking JB Hi-Fi ((JBH)), Premier Investments ((PMV)) and Eagers Automotive ((APE)), but specialty retailers only make up some 15% of the sector. 

The largest representation (40%) is reserved for Hotels, Restaurants and Leisure companies, which includes the likes of Crown Resorts ((CWN)) and Aristocrat Leisure ((ALL)), but also IDP Education ((IEL)), Webjet ((WEB)), Collins Foods ((CFK)), and SeaLink Travel Group ((SLK)).

As a matter of fact, Audeara ((AUA)), Mad Paws Holdings ((MPA)), BikeExchange ((BEX)), Harris Technology Group ((HT8)) and RedHill Education ((RDH)) are all part of Consumer Discretionary, but I doubt very much whether most institutions would know these companies exist.

Looking at the top of the sector, in terms of market capitalisations, I think the answers most among us are looking for are found in Aristocrat Leisure, Domino's Pizza ((DMP)), IDP Education, JB Hi-Fi, Breville Group ((BRG)), Lovisa Holdings ((LOV)) and ARB Corp ((ARB)), possibly also including Corporate Travel Management ((CTD)) and Webjet as the latter two would be featuring in this year's re-opening trade.

Aristocrat Leisure had become the largest and most influential representative for the sector. Aristocrat has equally been one of the best performing large cap stocks on the ASX over the past five years or so. JP Morgan confirms it has been one of few 'well-held' favourites in Australia.

More recently the index changed significantly because of the inclusion of Wesfarmers ((WES)) post divestment of Coles ((COL)). Wesfarmers is now the number one in the sector, but, reports JP Morgan, still Australia's institutions are overwhelmingly underweight the stock.

The top five for the sector, comprised of Wesfarmers, Aristocrat Leisure, Crown Resorts, Star Entertainment ((SGR)) and Tabcorp ((TAH)), now makes up 65% of the sector's weighting.

The JPMorgan Model Portfolio is Overweight the sector by 102bp through Aristocrat Leisure, JB Hi-Fi and Super Retail ((SUL)).

Rising Equities Are Getting Cheaper

Investors worried about that long-foreshadowed correction in equity markets might be heartened to read the Panic/Euphoria indicator developed by analysts at Citi has been trending downwards, even with share market indices in the US and in Australia at or near all-time record highs.

The not-so-good news, however, is that even after a sizeable retreat since the beginning of the year, that market sentiment indicator is still firmly inside the Euphoria zone.

Citi market analysts keep repeating to their clientele: based on the history of this indicator, going back to the late 1980s, there remains a 100% probability that share markets will retreat from current levels over the next twelve months, resulting in a negative return.

Offsetting the negative implications from this particular indicator, which, by the way, has had an admirable track record over the past two decades, is the fact that Citi's Bear Market Checklist doesn't seem too worried just yet.

The factor that continues to support US equities is the large percentage of positive earnings revisions that still is occuring as US companies continue reporting operational performances that beat analysts' forecasts.

Thus far in June, reports Citi, seven out of 11 sectors that make up the S&P500 are currently enjoying positive revisions to profit forecasts.

Unwilling to give up on their proprietary doom-forecaster, Citi strategists suggest maybe we should all become a lot less comfortable with these elevated valuations from the moment earnings estimates stop rising?

The irony about those valuations is, of course, that as earnings estimates continue rising, forward-looking multiples become cheaper and cheaper. Unless share prices keep rising, in which case we must agree with Citi's warning. The real danger for today's share markets is of anything happening to the outlook of ever-rising corporate profit forecasts.

In Australia, reports Shaw and Partners Chief Investment Officer Martin Crabb, the forward-looking Price-Earnings (PE) multiple for the ASX200 has been in a steady decline for months now. The primary reason is because Australian companies are equally still supported by rapidly rising profit forecasts.

On Crabb's analysis, the ASX200 is now trading on a multiple of just above 17x, which, it can be argued, is still a long way off from the long-term average of circa 14.8x. Having said so, it's also a lot lower than the 20x-plus readings from late last year. Earnings estimates in Australia have now superceded those from pre-covid 2019.

The biggest driver behind the positive trend in Australia are miners and energy companies, i.e. the resources sector with the added observation that valuations for resources stocks continue to look cheap, in particular when compared to your typical growth stock.

Crabb also observes price targets in Australia are rising more slowly than earnings estimates.

One factor that has equally been responsible for pulling back the average PE multiple for Australia's most important index has been the switch from Growth and Quality into Cyclicals and Value earlier in the calendar year.

What effectively happened between November and March is that money flowed out of High PE stocks such as CSL ((CSL)), Afterpay ((APT)) and Appen ((APX)) and into lower priced banks, insurers, mining and oil & gas stocks, and REITs.

This, on average, has had a deflating impact too.



Time For Quality To Shine

It has been the new theme that runs through portfolio re-assessments and strategy updates worldwide: economic growth momentum has probably peaked; investors should prepare for a slowing pace in the global economic recovery in the second half of the running calendar year.

How does one prepare for such event?

By adding more Quality to portfolios.


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