Bit of a tricky week on the markets, we had a pretty significant “risk off” swing last week where investors were spooked by the increase in bond yields that actually happened a week ago. There is a perfect correlation between the volatility index and how much rubbish spews out of the talking heads and financial commentators so I’ll try and focus on the facts without the emotions or hyperbole this week.
ASX 200 was down 4.3% and is now down near enough 6% for the month.
Looking at the sectors starts to give you a clue as to what’s happening, but it is unfortunately not the complete answer. Sure, IT stocks are generally more expensive, and utilities are exposed to higher bond yields, but financials were down 5% too, which are cyclical stocks that normally benefit from rising interest rates. Resources performed relatively well, despite energy struggling. What’s going on here?
There’s a couple of things going on here, so let’s re-classify the last month of returns and see what actually went down.
I divided the market using a few basic factors, comparing returns over the last month to the previous 5 months. I did this by ranking stocks into quartiles based on EV/EBITDA, PE ratio, Dividend Yield, ROIC, Market Cap and Earnings Revisions independently.
Return on Invested Capital (ROIC), Market Cap (Size) and Dividend Yield did not really explain the recent shift in the market, with stocks in all quartiles sold off by similar amounts. However, when I looked at the more traditional ‘value’ and ‘earnings momentum’ factors, things got a little more interesting.
Earnings Revisions – Positive Analyst Outlook = Biggest Declines
Company’s that analysts have upgraded the most (quartile 1) over the past 6 months have been sold off 3.4% during the past month, despite appreciating by 23.5% over the previous 5 months. Those companies in the second quartile have been sold off 5.5%, despite strong relative upgrades of at least 5%. However, companies that have received at least a 0.03% negative revision were sold off only 3.14%. This highlights the indiscriminate selling that can occur in a risk-off period like this and this is when opportunities to acquire good companies at fair prices pop up.
High Valuations = Worst Performers
The most obvious outcome of my analysis is that stocks with top quartile PE ratios or EV/EBITDA valuations (based on last years earnings) were the best performers over the previous 5 months and the WORST performers over the last four weeks.
Bottom quartile PE stocks, stocks with a PE under 13.4x, only declined 2.2%.
Top quartile PE stocks, PE ratio’s above 34x declined 5.66%
In fact, the relationship between returns over the past 4 weeks and PE is almost perfect.
And EV/EBITDA is a similar story. More expensive, the worst hit.
This is what I’ve been banging on about for a few weeks now. At this point in the cycle, the best performers, the darlings, the high growth names are NOT where you want to be invested.
Similarly, going forward, the opportunity isn’t probably in the very cheapest of stocks, but those in Q3 that might surprise to the upside and those in Q2 that might be a bit better quality than their current price implies. Sniffing around in the middle is where the opportunity to make money lies!
Anyway, not a lot in the way of outstanding performances last week. NVT got a takeover bid, gold stocks did well and some of the cheap value stocks (HVN, SUL, JBH, APO) survived the drawdown. Domino’s surprisingly did well… please explain?
Here’s the bloodbath list. Not many spared. If you’d like to hear a bit more about what I was thinking on the day, how I handle times like these and what my approach is, I’d suggest listening to the podcast episode we recorded on Thursday morning. You can find it here.
I’d love to write a whole diatribe on this weeks move, but to be honest, the podcast covers it all and I’m FLAT OUT.
Long story short is bond yields moved up quick, everyone got worried about slowing earnings growth and declining valuations (prematurely) in my view and momentum disappeared.
Have a good week, call me any questions.