What is the best equity strategy in such an uncertain environment? Much depends, of course, on the investor’s time horizon. In the short term, with such jumpy markets, reading the signals, especially in relation to Europe’s woes, seems suitable. But of course, volatility creates many risks. In the medium to longer term, it is likely that picking undervalued stocks will prove effective — provided they are truly undervalued. And of course in such an oligopolistic markets as Australia, that can be hard to find.
Deutsche Bank is saying that domestic cyclicals are looking cheap:
Domestic cyclicals (ie, retailing, transport, media, gaming, building materials) are trading very cheaply, on a median PE of ~11x. This is on par with the depths of the financial crisis, and they appear quite cheap relative to defensives. Still, the relative valuation case rests upon the reliability of forecast earnings, and recent data raises concerns that an earnings rebound may remain elusive.
Cheap, maybe, but has the market just got it right? Deutsche notes that the bias towards services is not good for listed companies:
Looking in more detail at discretionary spending, there is a further problem for domestic cyclicals. Spending on discretionary goods, where listed companies have more exposure, has been quite poor, falling 3% over the year to June. All of the strength has been concentrated in services, where the equity market has comparatively less exposure (eg, household spending money overseas on holidays, spending at cafes/restaurants that aren’t listed).
The conclusion for Deutsche is to look for service companies:
Areas of opportunity amongst domestic cyclicals/consumer exposure
1. Get exposure to services spending. Air travel is growing solidly, and fares are rising domestically. Casino spending is also growing at a good pace.
2. Retailers with exposure to recreational activity and home improvement are seeing considerably more momentum than clothing/footwear/electrical retail.
3. Food retailers look attractive. Defensiveness seems prudent in the current environment, and our analysis suggests food inflation could pick up.
4. Buy stocks with exposure to the whole economy, rather than specific sectors, given growth overall is solid. SEK and the banks fall into this category.
Our model portfolio contains Virgin, Crown, Seek, Woolworths & Wesfarmers. DB analysts also like Flight Centre, Qantas, Kathmandu, Premier, Dominos, Collins, Tatts.
Perhaps. But the assumptions about economic growth are questionable, given the international environment. About two fifths of investment in the ASX is foriegn, and foreign investors are becoming very wary indeed. The stock market has to be affected by international sentiment. For longer term investors, punting on “exposure to the whole economy” definitely has dangers. The best option is picking good management. I would not touch Qantas with a barge pole, for instance.