ASX at the close

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by Angus Nicholson, IG

Outlook for the ASX

The ASX has borne out the same concerning pattern seen in equity markets globally throughout August. The ASX has barely broken out of the 5500-5560 trading range through much of August. Despite what has in many respects been quite a disappointing earnings season. Trading volume in August has by-and-large been much lower than the 100-day moving average. There does seem to be a feeling in global markets that many investors are waiting for everyone to return from northern hemisphere summer holidays to see some direction in markets. With valuations high, and yields low, we have seen much of the gains in the past week being driven by funds seeking out the more safe-haven like parts of the market, such as utilities, consumer staples and piling into higher yielding names.

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ASX Earnings Season v. Market Expectations

With 125/195 companies having reported earnings so far, total earnings for the index have been 12.4% below where analyst consensus estimates were expecting. It’s only the energy and materials sectors that have managed to beat consensus estimates, which does help provide a little fundamental support to their recent rally despite their high price-to-earnings ratio.

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ASX Earnings v. Last Earnings Results

Earnings growth is down 16.3% since ASX companies reported their half-yearly earnings. Unsurprisingly, some of the biggest declines have been seen in the energy and materials sectors, but given that a number of these companies also beat estimates there is a feeling that some of the worst of the earnings declines in these stocks may be over.

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Top 15 Winners and Losers

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GWA Group has been the best performer of the past week after it ended four years of consecutive declines in net profits with its earnings release on 22 August. GWA has diversified its building fixtures and fittings business into more profitable business lines and its earnings are showing the benefits. Cleanaway Waste Management has seen a similar upside surprise in earnings, which has been warmly welcomed by investors. Monadelphous Group saw a huge drop after its earnings release failed to live up to its enormous rally, but it has such a large amount of short interest it could well see a bit of buying as people look to close these positions out.

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ASX Valuation

ASX valuations continue to trade at historically high levels. Currently, the forward P/E ratio on the ASX is sitting at 17.1 still almost 1.5 standard deviation above long term average for the index.

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Sector Returns

US dollar gains have been capped heading into the Fed’s Jackson Hole meeting, and this has been a huge driver for commodity prices over the past week which has helped materials stocks see one of the strongest performances in the index. But the other interesting development is investors rotating back into some safe haven sectors, such as utilities and consumer staples. The unnaturally low volumes and low volatility we are seeing in markets does appear to be driving some investors to hedge into some of these safe haven sectors.

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Factor Returns

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Alongside this is a very interesting surge in high yield stocks over the past week. High yield stocks returned 1.6% over the past week and 5.9% over the month. This seems to show that in this very low volatility environment investors seem happy to just pick up yield where they can rather than piling into momentum stocks in the hope of capital gains.

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Value Screens

I’ve tweaked Joel Greenblatt’s ‘Magic Formula’, which is earnings yield (earnings divided by price) times return on invested capital. I’ve ranked the stocks in the ASX 200 according to their Z-score, which is a reflection of their position according to the Gauss normal distribution. The key takeaway is that Qantas continues to look like a compelling value buy even after its strong earnings result as it has both strong earnings and is relatively undervalued – and has now committed to paying a regular dividend.

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Momentum Stock Picks

Note: These momentum stock recommendations are based off backtested results looking at a 3-5 day holding period with a 5% stop loss on every trade.

WPL – (Buy)

Woodside has continued to gain alongside the rally in oil prices and the solid work it has done in shoring up its balance sheet during the massive sell off in the oil price over the past two years. With oil prices firming up between the US$45-$50 level the stock looks set to hold up well.

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