Dougal Maple-Brown
Head of Australian Equities

The Australian equity market had an exceptional quarter, with the S&P/ASX 200 Index (Total Returns) rising 13.7%.  Australia outperformed what were buoyant global equity markets, driven higher by positive news around COVID-19 vaccines and a credible pathway out of the pandemic.  Australia’s outperformance was aided by containment of COVID-19, improved local economic data and a further loosening of monetary policy by the Reserve Bank of Australia.  Strength in commodity prices also helped the local market, with iron ore pushing above US$150/t and oil rising sharply.  The Australian Government 10-year bond yield rose 0.18% to close at 0.97% and the AUD rose materially against the USD.  Looking at performance by sector, Energy (+26%) was strongest, followed by Information Technology (+25%), Financials (+23%) and Materials (+15%).  Utilities (-5%) was weakest, followed by Health Care (-1%) and Industrials (+5%).

The December quarter saw a marked shift in investor sentiment, with optimism around an emergence from the pandemic and an economic recovery driving strong performance from the equity market and a rotation into out-of-favour cyclicals and other stocks particularly impacted by COVID-19.  We hold many such stocks in our portfolio and this shift provided a material tailwind to our performance and that of the ‘value’ investment style more generally.  Our resource holdings performed well, including Sims Group (+77%) and Woodside Petroleum (+29%), reflecting improved commodity market conditions.  Our overweight position in Nine Entertainment Group (+33%) benefited from a recovery in advertising markets and our holdings in Scentre Group (+26%) and The Star Entertainment Group (+20%) were seen as key beneficiaries of an economic re-opening.  The shift in market sentiment also saw the emergence of private equity and other bargain hunters and a number of our holdings were targets of corporate interest during the quarter, including Link Administration Holdings (+49%), Janus Henderson Group (+43%) and Coca-Cola Amatil (+36%).  Our decision not to hold CSL (-1%) contributed positively, although we note that it has not (yet) de-rated and still sits on a near record 42x forward earnings.  Similarly, our performance benefited from not holding gold stocks which were widely sold off during the quarter.

Whilst there was a clear rotation towards ‘value’ during the quarter, many of the hyper-PE growth stocks continued to outperform and our decision not to hold them detracted materially.  The key names were Afterpay Touch Group (+48%) which has never made a profit and Xero Limited (+46%) which made $3m this year.  Our decision not to hold Fortescue Metals Group (+44%) also contributed negatively, outperforming due to its very high sensitivity to the iron ore price.  Of stocks that we hold, QBE Insurance (-1%) underperformed following a profit downgrade and offshore earners Brambles (+1%) and Amcor (+1%) also lagged, largely reflecting currency headwinds. 

Dad – are we there yet?

During this holiday season many a parent will hear this question posed by a bored and frustrated child (although given the border closures perhaps a few less than would otherwise have been the case!).  In our September quarterly, we posed the question (admittedly not for the first time) as to whether we had arrived at the point in time when ’value’ was going to awake from its long slumber.  Certainly, there were signs that we might be approaching that point with the price earnings (PE) multiple spread between the most expensive and cheapest industrial stocks running at ~4 standard deviations.  In addition, we had seen corporate activity beginning to unlock value in some of the most unloved stocks – clearly some market participants had begun to see the opportunities on offer. 

As we look back over the past quarter there has been a significant change in sentiment towards the more value orientated segment of the market.  Is this indeed the long-awaited turn that we were questioning last quarter?  It might be.  When the turn came it was “violent” and in November our Australian equity strategy had its best single day of outperformance relative to the benchmark (also known as alpha) in ~20 years whilst the month of November was amongst our best 5 alpha months in over ~30 years.  In a significantly positive quarter for value, it is however important to note that:

  • much of the performance uplift came from a change in sentiment towards out of favour value stocks, driven by vaccine approvals which have lifted stocks that are expected to benefit from economies opening up.   Thus, over the quarter energy, banks (less bad debt fears), retail related and commodity names were strong (understandably there was then some weakness in these stocks in December as a third COVID-19 wave impacted many countries)
  • we saw corporate activity further recognising opportunities in undervalued names such as Janus Henderson, Link Administration and Coca-Cola – all represented in our portfolios.  Other stocks such as AMP also saw corporate interest.
  • performance benefitted significantly from not holding the highly priced growth stocks.  The critical point here though is that in general these stocks did not experience significant price retreats – they merely held their prices in a market that advanced strongly (~14%).  Thus, over the quarter highflying stocks such as Cochlear, CSL, Goodman Group and Transurban underperformed but saw little if any decline in their share prices.  They sustained the same high valuations that the market had previously attributed to them.  Where there was weakness, it was often attributable to an ongoing strengthening of the AUD as many of the growth stocks have significant offshore exposure.

Last quarter we expressed the view that focusing on the exact timing of a turn in favour of value was to miss the heart of the issue; which is the very significant upside opportunity when value does turn.  It has been greatly encouraging this quarter to see the sharp recovery that value has enjoyed – notwithstanding there being little or no correction in the extreme valuations attributed to the most popular stocks.  Thus, whilst we do think that from a timing perspective this is the turn for value that we have been waiting for – our focus is rather on the very significant relative performance upside that we believe awaits the value style.  Much of that upside will be derived from a de-rating of the premium rated stocks – which as the chart above indicates are trading at 3-4 standard deviations above where they have traded historically.  This valuation over-stretch is generally justified on the basis of the exceptionally low prevailing rates of interest – whilst taking no account of the related economic fundamentals that have brought rates to these levels.  In addition, one of the most consensus investment views currently is that inflation will not put upside pressure on interest rates in the medium term despite the use of extraordinary monetary and fiscal easing.  If nothing else the strength in commodity prices should at least raise a question or two and this consensus view could potentially be calamitous at the first sign of inflation raising its head.  The stated position of key central banks to allow inflation to rise above target levels should reinforce concerns.

It follows that our view is that much of the current enthusiasm for highly sought after growth stocks is nothing more than rampant speculation brought about by loose monetary policy.  This seems most evident in the US with Tesla Inc a great example; a capitalisation of ~US$600 billion on the back of a share price that has increased more than 6-fold this year, with a paltry forecast EBIT of ~US$2 billion for CY20.  Little wonder electric car programmes are being announced by a number of players.  Whilst not quite Tesla, we have our share of valuation extremes in our market with Afterpay having a market capitalisation of ~$33 billion and well into the top 20 largest stocks.  Xero’s share price has also enjoyed an enormous run and now sits just outside the top 20 with a market capitalisation of ~$20 billion.  Neither company is profitable as they invest for the future but this process makes any attempt at determining a sensible valuation extremely challenging – noting that Afterpay is now capitalised within 10% of the capitalisation of Telstra whilst Xero is within similar proximity to the capitalisation of Coles Group. 

Lest there be any doubt that valuations have stretched into the incomprehensible it is worth noting the PE multiples (for those that have earnings!) for some of the most sought after Tech companies in Australia: 

Australian Tech stock valuations beggar belief
Similar valuation trends globally

Companies included in custom index are Afterpay, Altium, Carsales.com, Domain, NextDC, REA Group, Seek Limited, Technology One, WiseTech Global and Xero. Source: FactSet, data to December 2020.

It might appear that value managers expect a Steven Bradbury style victory – to be the last standing when the overpriced, momentum names correct!  Whilst not particularly appealing as a prospect, that is at least partly the case given the extreme valuations highlighted above.  That is however by no means to say that there aren’t stocks/sectors where we see upside relative to the market.  In a market where many stocks are incredibly expensive, resource stocks such as BHP and Rio Tinto are trading at well below historic multiples (admittedly iron ore is trading well above sustainable levels and reversion will see earnings impacted) whilst in our view many other resource producers offer significant upside with commodities trading below sustainable levels.  Energy stocks offer significant leverage to any improvement in the oil price.  We also see banks as a sector with upside as earnings seem set to benefit from a write-back of recent COVID-related provisions that are unlikely to be needed (at least not in full).  In addition, banks trade at a significant discount to where they usually do relative to the average industrial company and we would expect at least some normalisation in this relationship.

As we enter into a very uncertain 2021 we remain utterly convinced that better times for value investors lie ahead.  The last quarter of 2020 was a small down payment on the value recovery but the chart below highlights that only a small measure of value’s underperformance has been recaptured.

A great quarter for ‘value’
But only a small blip in the recovery process

Source: Bloomberg, data to December 2020.

Further recapture may lie ahead in the first quarter (“yes we have arrived”) or it may lie further into the future – but undoubtedly the journey will be worth it!

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, Maple-Brown Abbott Sharemarket 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 or the Maple-Brown Abbott Australian Geared Equity Fund, investors should obtain the Product Disclosure Statement, available at maple-brownabbott.com.au, by calling 1800 034 402 or from your adviser and consider whether the product is appropriate for your circumstances. The Maple-Brown Abbott Sharemarket Fund is closed to new investors. 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.