With the rise and rise in the Australian equity market in recent months, investors should be pleased that most sectors of the market are enjoying the rally. All of the 11 major sectors of the market are now trading at levels above longer-term moving averages, suggesting their trend is up.
In terms of relative performers, however, defensive and high-yielding sectors have tended to hold sway over the past six months, with outperformance by healthcare, telecommunications, consumer staples and financials. That said, in the last few months, we’ve started to see some interest in more domestic cyclical sectors such as consumer discretionary stocks.
Time for cyclicals to shine
It begs the question: could global cyclicals like resource stocks – soon enjoy a bout of relative outperformance?
That’s possible given recent signs of improvement in the Chinese economy. Either way, the downtrend in resource stocks appears to be over, with the ASX/S&P 300 Metals and Mining Index starting to make a series of higher highs and higher lows.
Of course, the fate of resource stocks will continue to rest largely on China. Thankfully though, news from the world’s second largest economy is starting to look better.Since the bursting of the Chinese equity market bubble in October 2007, China’s stock market has been among the poorer performers in global markets. China’s weakness, moreover, has led to underperformance in Australian resource stocks. Each time the Chinese market has tried to rally in recent years, local resource stocks also then tended to outperform in the local market.
A proper China rebound
But each of these Chinese-led rallies ultimately failed. However this time could be different.
In the case of China, the market has underperformed because valuations reached excessive levels and investors grew ever fearful that the economy would succumb to a hard landing – due to the combination of slowing exports and policy tightening to deal with a runaway property market.
But China’s equity market is now quite cheap. And contrary to fears, the economy has so far dodged a hard landing. Indeed, growth now looks to be firming after what’s been a relatively well-engineered moderate slowdown.
While exports are still soft, the property market is picking up again after recent easing in credit policy and more support for public housing. The newly installed power regime has also unleashed a range of new infrastructure projects, especially in regional areas.
Numbers improve
In the year to December, the Chinese economy grew by 7.9% – up from 7.4% in the year to September. It was the first acceleration in annual economic growth since early 2010. Chinese steel producers have also lifted demand for their key intermediate input, iron ore, after running down excessive stock levels that had built up early last year. After collapsing to below $US90/tonne in September last year, iron ore spot prices have recently returned to the highs of last year at almost $US150/tonne.
Newfound Chinese optimism is also apparent in the stock market, with the Shanghai Composite Index up around 25% since its lows in early December last year. The market is once again making a valiant effort to break out of its five-and-a-half year downtrend. At only 10.3 times forward earnings, moreover, China’s MSCI equity index remains around 30% below its long-run average of 13.
Should China’s market continue to trend higher – and after a five-year slump it is probably due for rebound – it should bode well for local resource stocks. Note the ASX S&P/300 has already lifted by 23% since bottoming in July last year, though remains 30% below its recent significant high in April 2011. At around 12 times forward earnings, sector valuations are no longer as cheap as they once were, but are still a bit below their long-run average of 14.Whether or not resource stocks can manage to outperform against the backdrop of a broad peaking out in commodity prices is debatable, but in outright price terms, the worst of the sector’s downturn seems to be behind us.
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