Globally and domestically I think “momentum/GAAP (growth at any price)” stocks have passed the “peak on euphoria” stage (Facebook + WhatsApp were the peak) and the broader equity markets are in the “mature on optimism” stage.
I think it’s absolutely clear we have reached an inflection point in the GAAP/momentum vs. GARP (growth at the right price)/value relationship and I am now aggressively tilting our equity strategy to reflect that. In this world of hashtags #Iliketocallourstrategy #sellharesbuytortoises
As I have been warning for weeks, I think we are seeing a clear peak in ‘momentum’ being the main driver of share price performance. Momentum as an investment variable has peaked and you will continue to see money rotated from expensive momentum stocks to better value/yield/GARP laggards over the months ahead.
Every global and domestic macro scenario I can conceive, leads me to forecast this rotation back to large cap “tortoises” to continue. In fact I think it will accelerate as it becomes more obvious to all market participants that support from central banks will ease over the months and years ahead. The QE and ZIRP (zero interest rate policy) trade is nearing the end, but you don’t want to be there at the end in the biggest beneficiaries of those policies. Remember, the NASDAQ is up 244% from the 2009 low.
Less free money
The next move in interest rates, both domestic and global, is up. Central banks are also in the process of putting away their unconventional tool kit. We are heading towards a more normalised monetary policy environment and that is why, strategically, I need to make adjustments to broader equity strategy.
They key reason we were on the right side of global and domestic equity markets in the last few years was simple. We believed you did not fight the Federal Reserve, European Central Bank, Bank of England, Bank of China, Bank of Japan and RBA working in unison (forcing people out of cash into risk assets). On the other side of that, I must adjust the equity strategy to reflect less largesse from central banks moving forward.
To put it simply: less free money = less risk tolerance. Similarly: less free money = more volatility.
In a previous life when I was young and reckless I would have driven over the equity strategy cliff Thelma & Louise style. Not this time around: if anything, I am going to slow the car down well ahead of the cliff. That is the process I have been starting in these notes over the last few weeks by identifying Australian GAAP/momentum stocks I thought were at risk of a top-down driven valuation correction. That caution has proved warranted in that set of stocks.
Just to remind you of that broader list of momentum stocks I think are vulnerable to a further top down driven valuation correction, here they are again.
REA Group (REA), Seek ltd (SEK), Domino Pizza Enterprises (DMP), CarSales.Com (CRZ), Xero Ltd (XRO), Vocus Comms ltd (VOC), TPG Telecom Ltd (TPM), iiNet ltd (IIN), CSL ltd (CSL), ResMed Inc (RMD), Ramsay Healthcare (RHC), Sirtex Medical (SRX) ,21ST Century Fox (FOX),Navitas (NVT),G8 Education (GEM),OzFoxex (OFX),Vocation (VET),Donaco (DNA),James Hardie (JHX),Magellan Financial Group (MFG),BT Investment Management (BTT),Platinum Asset Management (PTM),Henderson Group (HGG),Credit Corp Group (CCP),Veda Group (VED),ASX Ltd (ASX),Macquarie Group (MQG), Brambles (BXB), Amcor, Fletcher Building, IOOF (IFL), Sydney Airport (SYD) and Transurban (TCL).
I want to make clear that this is my top down view of Australian stocks with characteristics that I believe make them vulnerable in the shorter-term to what is clearly a global correction in momentum stocks.
The problem when I write a list like this, even as it proves accurate, is the list of analysts/investors/companies who get their noses out of joint is long. It is like people have forgotten that shares can fall and it’s unusual for any stock to simply rise in a straight line no matter how good the company is. This is particularly relevant in a global trend change event. So let’s be clear, the list above, is a list of Australian stocks with vulnerable characteristics, the largest one being 12-month positive price momentum. It’s nothing more than that and it’s based on 22 years of sitting in front of screens reading price action signals.
What will happen next?
Once we have reduced exposure to high flying momentum names what do we do next?
My answer is that institutional investors should rotate to large cap laggards and individual investors should rotate to cash ahead of the seasonally weak May period.
Broadly I think it’s time to position more defensively and for individual investors, that does mean raising some cash from multi-year big winners in the momentum space. This advice is twofold because if all we are seeing is a rotation from momentum stocks to laggards, those momentum stocks will still underperform, but if this does morph into a more serious broader equity market correction, those momentum names will lead the correction, exactly as has happened on the NASDAQ and Wall St.
The likelihood of a broader Australian equity market correction taking hold is clearly rising. I am monitoring developments closely but remain strongly of the view the ASX200 will outperform Wall St on all likely scenarios. Australian equities (and Australian dollar) have done very well relatively on a switch from Japanese to US equities recently, but it must be said that any further significant weakness on Wall St or Tokyo will be very hard for us to ignore absolutely. The ASX200 is now up 6.8% in US dollar terms this year and that does make us increasingly vulnerable to a correction.
Could the ASX200 lose 5%? Absolutely, in fact it’s probably more likely than rising 5% in the next few months (banks ex div, May effect, tough Federal Budget). On that basis I am again focusing on where institutional investors who will remain fully invested will rotate to.
What to buy next?
The institutional rotational focus will be the ASX Twenty Leaders Index (XTL) with an emphasis on laggards (tortoises). Interestingly this week, one outperforming XTL member was Telstra (TLS), reinforcing our view it’s time to be invested in the “tracks”, not the “trains”.
Other XTL members that delivered outperformance of the ASX200 are: Origin Energy (ORG), Woodside Petroleum (WPL), Suncorp (SUN), Wesfarmers (WES), IAG (IAG), Westfield (WDC), Westpac (WBC), National Australia Bank (NAB), Commonwealth Bank (CBA), Woolworths (WOW), BHP Billiton (BHP) and AMP (AMP).
To me this shows you the rotational playbook and I think the rotation is correct in terms of relative performance positioning. Get right up the quality asset and quality management team curve.
The other place I am focusing attention positively is in large open shorts, particularly East Coast ones.
The untold story (yet) of the last few weeks in currency and equity markets globally is somebody or some group of investors has been blown to pieces. The scale and speed of moves in momentum equities and currencies, almost certainly ensures some big losses have been racked up, most likely by leveraged investors.
On that basis I am of the view that stocks with large open short positions will outperform on forced covering by leveraged investors against other losing trades. Interestingly big open shorts broadly outperformed in Australia this week and I expect that to continue. My number one play on this theme remains the 13% shorted JB Hi-Fi (JBH). Below is the price action in JBH over the last 10 trading days: note the underlying bid tone of short-covering.
JBH: shorts covering
It is time to be disciplined, sensible, selective, contrarian and very focused.
100% of Charlie Aitken’s fees for writing for the Switzer Super Report are donated to The Sydney Children’s Hospital Foundation
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
