Investors can make two mistakes when taking profits on stocks. The first is moving to a new idea without searching for better value within existing themes.
The second mistake is failing to revisit old ideas when valuations improve during market volatility. In the hunt for the next big idea, some investors forget about old ideas they know well and once believed in.
Consider banks. My colleague at this Report, Peter Switzer, recently argued that valuations of Australian bank shares are ‘out of whack’. I have said the same thing several times in the past few months, particularly considering the Commonwealth Bank.
Rather than take profits and cut banking exposure, another strategy is finding better value within the banking sector. As I have written before in the column, key European banks and, to a lesser extent, US banks, are attractively valued.
Rotating within a theme can be done through direct stocks. But with several key portfolio-rotation ideas involving global equities, it’s easier for retail investors to use Exchange Traded Funds (ETFs) or active funds.
ETFs are a simple, cost-effective way for do-it-yourself investors to tilt portfolio allocations, rotating from overvalued to undervalued assets within a trend.
Taking profits does not mean exiting an idea completely. Rather, reducing portfolio allocations to overvalued assets, such as Australian banks, and increasing allocations to undervalued assets like global banks.
Know that rotating from local to global equities adds currency risk to portfolios when using unhedged ETFs. Investing in global banks, for example, through an unhedged ETF also requires having a view on the Australian dollar, in addition to the underlying securities.
Moreover, asset rotations require patience and conviction. It can take years for undervalued assets within a trend to become overvalued.
That said, knowing when to take profits and rotate into undervalued assets is the key to long-term wealth creation – and often what separates great investors from the rest. As the ‘herd’ gushes about star stocks and sectors, the smart money quietly takes profits and rotates them into assets that fewer investors discuss.
Here are three rotation ideas to consider:
- Reduce exposure to Australian banks, increase exposure to global banks
As readers know, I have been bullish on banks, including Australian banks, since the early part of the 2020 COVID-19 pandemic. As global equity markets tanked, I wrote that the opportunity to buy Australian banks was the best in a decade.
My view was based on two factors. Rising inflation would require higher interest rates, which in turn would support bank net interest margins (the difference between interest received and paid) and bank earnings. Also, the Australian economy would avoid recession and a sharp rise in bad debts.
Led by CBA, Australian bank stocks rallied and are now mostly overvalued. CBA, for example, is on a forward Price Earnings (PE) multiple of almost 23 times, consensus forecasts show. By comparison, Bank of America Corporation, among the highest-quality US banks, is on a forward PE of just 8.3 times.
The chart below shows strong gains in the VanEck Australian Banks ETF (ASX: MVB), which tracks an index of seven local banks.
Chart 1: VanEck Australian Banks ETF
Source: Google Finance
My preferred tool for US banking exposure is the Betashares Global Banks ETF (ASX: BNKS), which tracks an index of 60 of the world’s largest banks (excluding Australia). The average forward PE ratio of stocks in BNKS is a touch under 9 times – or miles below key Australian banks.
Chart 2: Betashares Global Banks ETF
Source: Google Finance
- Rotating from gold bullion to gold equities
Yes, it seems a strange idea to rotate from physical gold bullion to gold equities, given the latter benefit from a higher gold price. But hear me out.
For several years, I have liked the prospects for physical gold in a high-inflation environment. As the chart below shows, gold in US dollars has continued to rally, delighting gold bulls and dismaying gold bears.
Chart 3; Physical gold bullion in USD
Source: Market Index
Gold equities have badly underperformed gold bullion over the past five years. The VanEck Gold Miners AUD ETF (ASX: GDX) has an annualised return of just 6.3% over five years to end-August 2024. Owning gold bullion instead of gold equities has been by far the smarter play over that period.
Large gold companies have made plenty of mistakes over the past decade, notably spending too much on acquisitions and mismanaging costs. But the sector, collectively, looks undervalued given its leverage to the high gold price.
Although I don’t expect gold to maintain the pace of its current rally in the next few years, the medium-term prospects for the metal are solid given higher inflation and expectations of a gradually weakening US dollar.
GDX, which tracks an index of 54 global gold companies, is my preferred ETF for exposure to gold equities About 10% of GDX is invested in Australian gold stocks.
Chart 2: VanEck Gold Miners AUD ETF
Source: Google Finance
- Lighten exposure to Indian equities, lift exposure to Chinese equities
On paper, this looks a contentious idea for emerging-market asset allocations within portfolios. China has been in the news for all the wrong reasons: an ongoing property crisis and disappointing economic growth by its standards.
India, in contrast, has had strong economic growth and decent growth in corporate earnings, particularly in the tech sector. Expectations of a rate cut and a strong influx of retail investors have also driven equity valuations higher.
CNBC this week described Indian equities as reaching ‘dizzying heights’ after a record-breaking 14-day rally. With India’s GDP growth starting to slow, and more retail investors buying late into the rally, it has signs of an overheating market.
The Global X India Nifty 50 ETF (ASX: NDIA) has returned 16.1% annually over five years to end-August 2024. In contrast, the iShares China Large-Cap ETF (ASX: IZZ) has an annualised negative return of -5.6% over that period.
Chart 3: Global X Nifty 50 India ETF
Source: Google Finance
I am no expert in valuing Chinese or Indian equities. I do know, from experience, that when one asset is soaring as retail investors join the party late (Indian equities) and another is massively out of favour (China), it’s time to take some profits in the former and consider rotating into the latter.
As with all emerging-market equities, ETFs over Chinese equities suit experienced investors who have high risk tolerance. This is not an idea for the risk-averse, new investors or those with a short-term investment timeframe. A recovery in Chinese equities could take years to play out, with further short-term losses possible.
The iShares China Large-Cap ETF, which tracks an index of 50 Hong Kong-listed stocks, is my preferred tool for exposure to Chinese equities via ASX.
Chart 4: iShares China Large-Cap ETF
Source: Google Finance
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at 11 September 2024.
