They are in the sin bin at the moment, but some of the market’s worst performing sectors are likely to be the first to turn around when conditions start to improve.
Retail and consumer discretionary stocks, media and even banks will be among the first to bounce back if history is any guide. They are the first to feel the ill effects of economic downturn but among the earliest to benefit when consumers start spending and business conditions improve.
Equities analyst Julia Lee says that because the stock market is a forward-looking indicator, many of the stocks that are most sensitive to the economic cycle will start to rise three to six months ahead of an actual turnaround, a reverse of what we are seeing now when the market is pricing in a recession here because of what is happening in the U.S., Japan and Europe.
The risk for investors who buy now is that Australia does enter a long recession and company earnings continue to fall, in which case stock prices will be slow to recover. Uncertainty over the economy and the outlook for companies have made analysts reluctant to recommend stocks that are most sensitive to the cycle even though they see value in many of the companies.
Lee says that much of the bad news has been priced into consumer discretionary stocks such as David Jones, Harvey Norman and JB Hi Fi but she would still not be buying until around the second quarter of next year “and it depends on what is happening globally.”
UBS strategist David Cassidy describes the sector as “tricky” because the fiscal stimulus announced by the federal government could well boost retailers over Christmas and into January. But he fears the short-term boost could fade quickly.
“I think consumer spending growth will be sluggish for the next 12 months.”
UBS believes Australia will narrowly avoid a recession and Cassidy says the next three to four months will be crucial for all stocks, but particularly for those related to consumer sentiment. He says investors could accumulate on weakness a quality stock such as Harvey Norman and wait out the recovery “but I would be in no particular hurry.”
Retailers of consumer staples, such as Foster’s and Woolworths, have proved resilient because consumers tend to keep buying beer and groceries even when times are tough. “Woolworths relative to the market has been quite a good performer so from that perspective – on relative value – I would not be adding to that part of the market at the moment,” says Cassidy.
Financial stocks are unlikely to turn around within six months, having been hammered not only by bank crises abroad but large equity raisings here. The NAB placement this month and the dividend reinvestment plan raisings by Westpac and ANZ have depressed prices, which could be hit again if the Commonwealth and Suncorp decide to raise equity. All of them will be affected as investors reweight portfolios to take account of new issues but Julia Lee says the banks are looking like good value for anyone with more than a seven-year time frame. “My concern is that share prices could fall further because of the potential capital raisings.”
She is looking to accumulate banks over the next six months. Lee says the turnaround could happen very rapidly because banks are good value over the long term and warns that investors waiting to pick the bottom of the cycle could miss the start of their recovery.
David Cassidy has a hold on the sector and says he would not be selling at these levels. “The price-earnings ratios and dividend yields are looking pretty attractive.” Cassidy also notes that the Australian financial sector has fallen in line with the U.S. and U.K. banks although local banks have nowhere near the same problems.
Media stocks are already feeling the impact of a downturn because business cuts advertising early and job ads fall but they also bounce back quickly when there is a glimmer of confidence. Companies could also benefit over Christmas as advertisers compete for some of the government’s payment to pensioners and going into the new year from the rest of the fiscal stimulus. This could be short lived, however, if the economy goes into recession in 2009. An added complication for the sector is that some companies are carrying high levels of debt and vulnerable to takeover. Recovery is unlikely within at least six months.
Lee expects to see some consolidation in the sector and says there is substantially more risk in media than other sectors. “I would not be accumulating media stocks at the moment but I might look at the sector in the next quarter,” she says.
Health care should be fairly immune from economic cycles and has been one of the market’s better performers, down only around seven per cent in a year. But that reflects CSL’s dominance of the sector and the boost that the lower Australian dollar is giving to the company’s earnings rather than confidence about health-related companies. Many of the sector comprises small companies which are finding it hard to attract attention when even the blue chips are sliding. While a recession looks possible, smaller companies will continue to be ignored in favor of blue chips with good cash flow, a history of profits and the size to ride out tough times. When the recovery comes, some of the companies that have been battered the most will already have started moving.