We’re in a bull market and there’s no guarantee laggard stocks will catch up
In a two-speed market there is no guarantee stocks in the slower lane will catch up.
Were we to stick with our traditional, pre-Covid interpretation, we’d say the sharemarket is in a prolonged bear market that has been masked by a small number of companies that have performed exceptionally well and kept major indices on a positive uptrend.
This is not dissimilar from observations made about equity markets in the US, for example, where the large majority of index constituents has failed to make a positive contribution, despite indices rallying to new all-time record highs.
Most investors don’t like to talk about bear markets, so let’s switch this conversation to a more positive starting point: equity markets are enjoying a new bull market – every other week we see fresh new records – but large swathes of stocks are not participating.
The post-Covid bull market is characterised by a narrow base of big winners and a larger group of sharemarket laggards.
It is this polarisation, I believe, that is reflected in the large overweight in positive ratings because, well, many more companies look “cheaply” priced, while indices are seen trading on elevated multiples.
The same underlying polarisation becomes obvious when we compare the performance of various indices for US equities at this mid-year.
In the year to date, the S&P 500 has gained about 18 per cent but the S&P SmallCap 600 index is down 2 per cent for the period.
In Australia, the dynamics have not been fundamentally different.
The ASX 200 Accumulation Index year-to-date has returned 4.22 per cent, of which half is from dividends. The Small Ordinaries has only returned about 2 per cent.
Is ‘Value’ Ready To Catch Up?
I am sure we can debate for hours whether “bull market” is the appropriate label for those numbers, but it’s not difficult to see why investors would be more inclined to seek “value” among the laggards, given the large gaps in share price moves and also amid widespread concern about too much exuberance in popular stocks.
The problem with such a simplistic, value-based approach is that economies are slowing, and cracks are appearing in household spending and small businesses.
What this means is sharemarket laggards might look “cheap” and “attractive” for good reason, and that reason might be a deteriorating outlook.
I’d say, investors are all too aware that risks are rising. A recent report by JPMorgan suggests local fund managers have been sharply reducing their exposure to the materials sector, with JPMorgan analysis suggesting the third-largest outflow on record occurred in May (the most recent sector data available).
Local fundies remain heavily underweight Australian banks, but they also have started yet again to embrace defensive supermarket operators Coles (COL) and Woolworths (WOW).
In a market characterised by extreme polarisation, as are sharemarkets currently, the risk profiles for winners and laggards appear diametrically opposed. What should investors worry about most? Is it that certain share prices might have become too bloated or is it about the next profit warning waiting to be revealed?
Within this context, it’s good to know that the technology sector traditionally enjoys solid support from investors in July (not exactly clear as to why), with Pepperstone head of research Chris Weston reporting the Nasdaq100 has posted gains in July in 15 times out of the past 15 years.
It is also not difficult to make the argument that many of today’s sharemarket winners are in excellent shape, and performing well operationally, maybe with the notable exception of Australian banks.
Witness, for example, the recent sharemarket updates by the likes of Aristocrat Leisure (ALL), Xero (XRO), Gentrack (GTK), Webjet (WEB), Tuas (TUA) and TechnologyOne (TNE), to name but a few positive standouts.
Given many of today’s winners are carried by investor optimism on GenAI, with US markets in pole position, maybe the time to start worrying about share prices in Goodman (GMG), NextDC (NXT) and WiseTech Global (WTC) is when Nvidia et al experience a serious correction?
Meanwhile, owning shares in companies that are unable to meet expectations, either this month or in August, can be quite a deflating experience. Within this context, I note shares in Fletcher Building (FBU) have now lost about 46 per cent over the past 12 months, of which 29 per cent occurred in the past three.
Shares in Orora (ORA) are down respectively 36 per cent and 27 per cent over those periods, while for Eagers Automotive (APE) the corresponding numbers are -22 per cent and -26 per cent. Shares in Cettire (CTT) more than halved in the immediate response to management’s downgrade. They have since rallied off the low point, but are still substantially below the share price pre-profit warning.
Bottom line: cheaply priced assets might take a lot longer than many expect before narrowing the gap with the top performers in today’s sharemarket, especially if economies slump more deeply than expected or rate cuts are pushed out further into the future.
Rudi Filapek-Vandyck is editor of sharemarket research service www.fnarena.com
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