The equity bulls are loudly spruiking their bull and the big cap stocks might be a beneficiary. A report by Southern Cross Equities (see below) puts the case. It notes that most equity strategists are recommending only “neutral” sector weightings in the two major sectors in Australia, materials and financials. But Southern Cross’ “multi-factor quant ranking screen” says otherwise. It ranks materials as number one, insurance as number two, capital goods (including contractors) at three, diversified financials at four and banks at five. It may come as a surprise that not everybody is entirely convinced by multi factor quant analysis; which simply tracks numerical norms and has little to say about anything involving human behaviour, market sentiment or company culture. In other words, what matters.
But it does help give some kind of base line and with sentiment still cautious, stock pricing fairly straightforward and the economic environment appearing to be predictable, it might even represent useful information. The Southern Cross report advises buying the big boys:
One of our major strategy themes this year has focused on the expectation of big cap outperformance within the benchmark ASX 200 index and a rising equity market. Yet, clearly we remain bullish on a variety of small caps at a stock specific level, particularly small resources, those who service them, market linked financials and biotechs.
However, trading at a similar forward multiple as the ASX 200, compared to an historic discount of 15-20%, we believed, the risk/reward equation of the Small Ords had deteriorated and the big caps offered significantly better relative value. In addition, we also highlighted our expectation that in the short term the strong technical ASX 200 resistance level of 4800 would be tested and ultimately broken. It has. Subsequently, we expected that the strong outperformance of the big caps would lead a quick advance to the 5000 index level, and possibly beyond.
This may be an accurate read of an emerging shift in sentiment. As the GFC recedes into the memory, and with gearing falling it may be time for some reckless enthusiasm about big cap stocks.
But there is a pretty strong counter case. With the $A still high, there is no currency play for foreign investors. Indeed, there is a strong currency risk. Foreign investor purchases of Australian equities, but it is still a long way short of the $60 billion inflow in 2009.
Retail investors are still chary of the market. Households’ exposure to shares is at a 15 year low. They are still opting for bank deposits over direct share investment, although they are lifting their super contributions. It is possible to read this as cash that may shift towards stocks, or not if the conservative mood persists.
Same goes for domestic super funds are still funneling capital into the market because they have to, but even there the cash holdings are high.
It does not look like grounds for a spectacular re-rating at this stage at the big end of town. There does not seem to be any obvious example of mis-pricing, valuations look unremarkable. Mining will of course be strong, but that is already in the price, and many of the domestic cartels will struggle to find growth, especially those exposed to the wrong part of the two speed economy.
Those neutral ratings may more accurately reflect the mood at this stage.