John Jeffery |
There has been some excellent research conducted over the years that identifies the best performing managed funds. What is often most notable is that the same funds that outperform one year are often the exact same ones that underperform the following year. Usually, these funds are polarised by their constituent components; the fund which is extremely long on cyclical stocks does well during the bull market, but crashes miserably as soon as risk appetite and global growth decline. Equally, during the bear market, the outperformance of the defensive funds is soon eroded as the market bottoms and eventually turns. The same can also be said for different stocks and sectors. With that in mind, this article will review the relative performance of the Australian sectors heading into the recent bear market low and investigate which of those have leaded the recovery. The latter parts of the article will go on to suggest which sectors may provide the most potential growth opportunities into the next 2 quarters; or at least those which are more defensively placed to weather any lacklustre developments. By contrast the more vulnerable areas can be looked at as sectors with abundant candidates for short positions.
Research undertaken by Fana and French, Poterba and Summers as well as De Bondt and Thaler suggest that buying shares that have performed badly over medium term horizons are likely to give above average returns over future medium term horizons. In research parlance, it is recognised that stock returns over the short term (i.e. a week or a month) are quite positively correlated. This should come as no shock. The usual push and pull that day to day events (be them of economic or political origin) have on the markets tend to effect every stock out there – typically, if it’s a down day on an index, ‘most’ stocks are down. Over longer time horizons (6 months up), stocks are seen to display negative serial correlation, however. Again, when the changes in consumer, technology and bigger picture trends are taken into account, it’s quite obvious that some sectors are more favourable to others in the changing business cycle. Add to this, the natural tendencies of market participants to overshoot and undershoot stock valuations and you have the opportunity to exploit the relative inefficiencies.
In order to understand the future it’s important to have a clear grasp on the recent past, and to display the recent price action in a meaningful fashion requires some manipulation of the data. Simply looking at charts in ProfitSource or HUBB Investor will not allow for a fair comparison of price movements in the sectors - they all need to be adjusted to start at a ‘zero’ price and the movements considered in percentage terms.
The chart below looks at five different sectors and the top 200 stocks on Australia as a control:
XJO – ASX Top 200 stocks
XMJ - ASX Materials Sector
XFJ – ASX Financials Sector
XEJ – ASX Energy Sector
XDJ – ASX Consumer Discretionary Sector
XSJ-ASX Consumer Staple Sector
click to enlarge
The period of the chart starts on the 1st of November 2007 which coincides with the XJO’s all time high of 6852 and ends on the 10th March 2009 with the most recent bear market low. As you might expect, the XJO represents something of an ‘average’ with 3 sectors presenting positive alpha (above market returns) and 2 underperfoming. Looking at the extremes, the best performer over the period (i.e. the most resilient sector to the bear market moves) was energy; followed by the defensive, consumer staples. Consumer discretionary and the financial sector were the worst performers.
If the research cited earlier is to believed, the sector performance during recovery should indicate something of a polar opposite. Those sectors which offered the best returns and safe havens will be the exact same that restrict portfolio growth as the business cycle changes.
The chart below goes some way to validate these theories. The same sectors are viewed over a time period running from the 10th March 2009 until the 20th October (time of writing).
click to enlarge
Consumer discretionary and energy are now very much the laggards, whereas the heavily sold financial and consumer discretionary are the best sources of alpha. Stock pickers focussed on Australian Banks as well the likes of Harvey Norman have been duly rewarded. In this chart I’ve added the Telco sector as well.....cruel, I know!
As we move towards the next period of stock market price action (away from the ‘value’ driven rally) there are going to be some excellent opportunities switching out of the financial and discretionary sectors back into the energy and consumer staple sectors. Although the much talked about correction is still ‘just around the corner’, profits can be taken on those individual stocks which have lead the recovery and lined investor’s pockets. Oil and alternative energy stocks will be most resilient in the forthcoming correction and offer good returns with the ‘real’ bull market which is still ahead.
Stay Sharp,
John Jeffery
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