Head of Australian Equities
The Australian equity market had a strong quarter, with the S&P/ASX 200 Index (Total Returns) rising 4.3%. Australia modestly underperformed what were buoyant global markets, driven higher by increased optimism around the emergence from the COVID pandemic and associated economic recovery. Local economic data was positive, with 4th quarter GDP and inflation above expectations, improvement in the labour market and continued strength in housing. The February company reporting season also exceeded expectations. Rising bond yields were a key feature of the quarter, with the Australian Government 10-year yield increasing by 0.82% to close at 1.79% and the US 10-year increasing similarly. The AUD was steady against the USD. Commodity prices were robust, with oil and base metals seeing solid gains and iron ore remaining elevated. Looking at performance by sector, Financials (+12%) was strongest, followed by Communication Services (+9%) and Consumer Discretionary (+9%). Information Technology (-11%) was weakest, followed by Health Care (-2%) and Utilities (-2%). Energy (+4%) and Materials (+3%) modestly underperformed.
Increasing economic optimism and expectations of higher inflation and interest rates supported a broad rotation away from ‘growth’ and defensive stocks towards cyclicals and other out of favour ‘value’ stocks. This shift, often called the ‘reflation trade’, provided a strong tailwind to our performance. Our exposure to the major banks contributed positively. We were overweight the strongly performing sector and had our holdings focused in the more value-oriented banks which were the best performers. Our overweight holding in Incitec Pivot (+28%) outperformed, reflecting a recovery in fertiliser prices and associated improvement in earnings outlook. Our overweight position in Telstra Corporation (+17%) performed well. Earnings headwinds from the NBN are now largely behind them and the mobile market is continuing to show signs of recovery. The stock further benefited from an update on the separation of its towers business. Our decision not to hold CSL (-6%) was also supportive. The stock was impacted by the rotation away from growth stocks as well as concerns around its earnings outlook due to constrained plasma supply.
Our overweight position in Link Administration Holdings (-7%) contributed negatively. The company had recently been the target of two takeover offers, however, the withdrawal of one of the bidders during January created uncertainty around the likelihood of a transaction. Our overweight holding in Orica (-8%) underperformed. The company provided a trading update in February, warning of several headwinds including trade relations with China, COVID demand disruptions, a stronger AUD and SAP software implementation costs. The company also announced a transition in CEO. We believe the reaction to the announcement was excessive, given the temporary nature of the issues, and that significant value should be realised over the longer term, sales levels, and the potential impact on earnings.
The start of a sustainable value cycle?
The one-year anniversary of the start of the global bear market in February 2020 and the declaration of COVID as a global pandemic (World Health Organisation on 11 March 2020) have both passed. At the time of the declaration the official global death toll was ‘only’ 4300 – a sobering statistic seen in the light of subsequent tragic events. It has been an extraordinary year for mankind, but also to a much lesser extent for investment markets. The table below highlights a few key statistics over the course of the year. If the reader ignored the ‘23 March 2020’ column, one might be fooled into thinking it had been a dull 12 months in markets!
|20 Feb 2020(1)||23 March 2020(2)||31 March 2021|
|Aus 10-year bond rate||0.99||0.92||1.79|
|S&P/ASX 300 Total Return Index||76910||49090||75927|
|ASX 300 FY22 Forecast EPS(3)||404||404||356|
|MSCI Aus Value/ASX300||100||94||103|
(1) The date the ASX/S&P 300 peaked
(2) The date the ASX/S&P 300 troughed
The big difference between March 2020 and March 2021 in an investment sense is the extraordinary amount of fiscal stimulus by governments globally which has seen long term interest rates in countries such as the US and Australia bottom decisively. This has been a key factor in the outperformance of the value style since October after an extraordinary further downdraught subsequent to the stock market high of February 2020. The subsequent recovery in value manager performance has been almost as significant as we saw in the six months from August 2016. It is perhaps not surprising that some are already asking whether this is it for the value rebound! However, we believe this is the start of a sustainable value cycle.
It is worth looking back to where the key industrial growth stocks were trading at the time of the August 2016 set-back for growth. The price earnings (PE) multiple of the 40 most expensive stocks at that date was 26.8 times whereas that multiple today remains over 40 times, even after the current de-rate which has contributed to the strong recovery in value manager performance. This is notwithstanding the fact that 10-year bonds, after the sharp recent de-rating, are trading in line with the 1.8% level that we saw in August 2016.
To further the point, CSL the largest growth stock, was trading at a 28 times forward PE at the start of the August 2016 correction while today the PE is 39 times - after the current correction! Macquarie Bank, another of the market’s favoured stocks was trading at a price/book value of 1.6 times in August 2016 and is currently trading nearly 50% higher at 2.5 times. Thus, while we have seen some underperformance from key growth stocks much of this has come about through the re-rating of many of the out-of-favour value names (some of that via M&A activity), rather than from a collapse in the share prices of growth stocks. The table below highlights this point.
A strong turn for value from Q4 with growth underperforming
Except for ‘valuation agnostic’ Tech
|Stocks total returns 6 months to 31 March 2021|
|Value stocks||% change||Growth stocks||% change||Hyper-growth stocks||% change|
|Sims||97%||Wesfarmers||21%||EML Payments Limited||72%|
|Australia & NZ Banking Group||67%||Aristocrat Leisure||15%||Seek||34%|
|Nine Entertainment Co. Holdings||61%||Cochlear||7%||Afterpay Touch Group Limited||30%|
|Westpac Banking Corporation||47%||ResMed||6%||REA Group||30%|
|Incitec Pivot||43%||Goodman Group||2%||Idp Education Limited||26%|
|Woodside Petroleum||37%||Transurban Group||-5%||Xero Limited||26%|
|BHP Billiton||31%||CSL||-7%||Zip Co Limited||2O%|
|ASX 300 Acc. Index||+18.5%|
As we analyse price movements over the past six months of value manager outperformance, we can clearly see that many of the out-of-favour names have had a very strong recovery with the banks playing a significant role in that. In addition, resource stocks have continued to benefit from positive sentiment as commodity prices have seen ongoing strength. While growth stocks have generally lagged the strength in the market, they have in general not seen significant absolute price weakness – leaving them trading on the premium PE multiples reflected in the first chart. What is particularly noteworthy is the performance of a third group of stocks — the ‘hyper-growth’ stocks (largely Tech related). Many of these stocks have shrugged off higher interest rates, with stock prices moving higher and continuing to trade at eye-watering multiples (albeit off their peaks).
Where to from here for the value style? Is this another repeat of the 2016 cycle — six good months and then a long winter of discontent for value managers? The analysis presented above suggests that there is opportunity for further significant outperformance for the value style as the extreme valuation differentials continue to be addressed. This view is supported by the chart below which highlights the significant potential upside following an extended period of underperformance for value.
A strong period for 'value
But only a small step in the recovery process
We have often highlighted that care needs to be taken when analysing value and growth benchmarks in Australia and thus in interpreting charts such as the one presented here. The concentrated nature of our market often sees marginal decisions having to be made by the benchmark providers regarding which benchmark a stock should be allocated to (and some stocks are partly allocated to both). However, a glance at industry performance tables over anything other than the shorter term confirms that value managers in general are significantly lagging market benchmarks, and even more so lagging their growth peers. The valuation data presented at the beginning of the report clearly identifies the underlying causes of this disparity.
In summary, while the recovery in value manager performance has been a welcome relief to value managers and their clients, any historical perspective highlights there is significant potential for further outperformance by value. There is much to be optimistic about:
- The interest rate cycle has in our view turned decisively. Given the extraordinary amount of fiscal stimulus and the stated willingness of monetary authorities to keep their foot off the ‘brakes’ to encourage inflation, a repeat of 2017-2020 when interest rates fell sharply seems highly unlikely.
- Notwithstanding the significant recent bounce in value manager performance, the longer-term underperformance of the value style (whether that be relative to growth or the market as a whole) means that relative performance remains below where it was when the 2016 recovery commenced, let alone where it finished in early 2017.
- For the past decade investors have operated in an environment of low growth, low inflation and falling interest rates. This has seen growth stocks trade at valuations which are multiple standard deviations away from historic averages, and for an extended period. Central banks and governments are doing their utmost to encourage both economic growth and some inflation and given the resources applied to the task, some measure of success seems likely. Interest rates should be expected to rise further. Under this scenario it is entirely plausible that the value style could have an extended time in the sun. Why should value stocks not trade at a standard deviation or two (or three) above historic levels over coming years?
We look forward to writing further about this in coming months.
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Maple-Brown Abbott Limited (MBA) ABN 73 001 208 564 AFSL No. 237296 is the responsible entity of the Maple-Brown Abbott Australian Share Fund and Maple-Brown Abbott Australian Geared Equity Fund. Before deciding whether to acquire, or to continue to hold, an investment in the Maple-Brown Abbott Share Fund investors should obtain the Product Disclosure Statement, available at maple-brownabbott.com.au, by calling 1300 097 995 or from your adviser and consider whether the product is appropriate for your circumstances. This commentary contains general information only and does not take into account individual financial circumstances. Any comment we make about individual stocks are intended only to explain our approach to managing funds and are not recommendations intended to influence anyone in making an investment decision. An investment in any of the Funds does not represent an investment in, deposit with or other liability of MBA. It is subject to investment risk, including possible delays in repayment and loss of income and principal invested. MBA does not guarantee the return of capital, performance of any of the Funds or any specific rate of return.