CONTRIBUTED ARTICLE by Jun Bei Liu*. There is never a dull day on the share-market. The end of the volatile reporting season marked the beginning of the great rotation from recent winners into losers, so to speak. The US equity market staged a five-standard deviation rally – a particularly rare event – of value verse momentum on September 9, causing a ripple effect throughout the world.
Shares in companies with strong earnings growth and price appreciation were sold off and replaced with companies that have earnings leverage to the upswing of the economic cycle. While there is still debate on the exact trigger, it would appear most likely to be the extreme positioning and valuation differential between the stronger earners and the down-graders. A sharp move in the bond yield was also attributed to be the root cause of the shift as investors turned more optimistic on the global economy with a temporary truce in the trade war, as well as stronger inflation data.
As an Australia-based equity investor, it was fascinating to watch the share price of reporting season underperformers, such as Boral Limited (ASX: BLD), back to almost pre downgraded levels in just over two weeks. The same could be applied to other building materials companies, most notably Brickworks Limited (ASX: BKW), which rallied ten per cent on the back of a meaningful downgrade in the past week.
Looking at the fundamentals, very few things have changed in the past week aside from marginally better credit data released in recent days. Building completion rates remain elevated and while demand seems to be holding steady with the housing market showing signs of stabilisation, it will be a while yet before we are to see real improvement in building construction activities.
Gearing levels also remains high in the sector, with the coming 12 months set to prove challenging for many stocks. Valuations may seem relatively cheap and with earnings and financial risks remaining high, it’s rational to steer away from such a level of risky trade.
Elsewhere in investing-land, mergers and acquisitions activity is heating up, with many companies rumoured to be looked at by private equity firms. Cheap money and lack of growth will see this trend continue and we are expecting to see many more deals firming up in this remaining quarter of the calendar year.
The equity market is also likely to be buoyed by these announcements as investors extrapolate valuations against the rest of the sector. One notable transaction recently was the Chinese-owned Mengniu Dairy Company’s bid for Bellamy’s Australia (ASX: BAL), with the market seeing a meaningful rally across most Chinese-facing stocks such as Blackmores (ASX: BKL), The A2 Milk Company (ASX: A2M) as well as a few other food-related names. Again, we would hesitate in chasing potential targets, as many of these potential takeovers fail to materialise and investors are then left with poor quality earners with elevated valuations.
Lingering trade war concerns, Brexit and other geopolitical uncertainties will continue to impact corporate profits, with most companies missing already downgraded FY19 earnings targets and guiding to a softer FY20. Commentary from trade related sectors have all focused on the uncertainties and disruption caused by the tariff escalation and its consequent impact on investment confidence.
The Australian market is at an interesting crossroads with economic data continuing to point to weakening housing and employment trends. Indebted consumers have further tightened discretionary spending since the election and construction activity is rapidly softening. With that in mind, the co-ordinated efforts by APRA and the RBA’s two pre-emptive rate cuts, could see the fall in the housing market cushioned and we could see a bottoming in activity over the next 12 months.
Loose monetary policy and fiscal stimulus should provide a supportive environment for the Australian equity market for the remainder of 2019. Outperformance of the Australian market against global peers is likely given both its defensive earnings as well as strong yield on offer.
Hence, it’s without question September once again remains an interesting month for the share-market. The market is very light with stock-specific news and investors are swayed by macro news flow and sentiment. As always, our advice would be to stick to the known quantities and, as an investor, revisit the fundamentals by taking advantage of share price volatilities.
*Jun Bei Liu is a portfolio manager for Tribeca Investment Partners.
This article was originally featured in AFR Market Minds.