May In Review: Banks Rise, Technology Falls

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During May net earnings revisions were positive for the ninth straight month, propelling the ASX200 2.3% higher, with the bank sector leading the way.

-The ASX200 climbed 2.3% during May
-Value outperformed growth and large caps outpaced small caps
-Banks were the best performing sector, Technology the worst
-Sector suggestions
-Stock picks for the Technology and REIT sectors

By Mark Woodruff

The ASX200 rose 2.3% in May, outperforming the 0.7% rise in the S&P500, while the Nasdaq fell -1.4%. The gains in the Australian market were driven by large caps, with the ASX50 outpacing the Small Ordinaries over the month.

The gap to pre-covid expectations continues to close with FY22 EPS levels now -3% below that high watermark. The Banks and Resources sectors continue to drive both the earnings pulse and index performance year-to-date.

Global Value outperformed Growth in May, driven by a rally in Energy and Financials. The largest move was in US Value, which outperformed its Growth counterpart by 422 basis points. Australian Value outperformed Growth by 101bps, while the EU was the only region to see Growth outpace Value.

Globally, since the end of October 2020, Value has outperformed by 14.0%, while Value in Australia has outperformed by 30% over the same period.

Banks were the best performing sector and Technology was the worst. In a tilt to quality, Healthcare returned to a positive contribution whilst Energy remains the clear laggard.

Emerging markets outperformed developed markets for the first time since January, with strong performances from India and Russia, rising by 6.4% and 7.9%, respectively.

Australian sector performance

Banks were the best performing sector, up by 7.3% overall, led by Commonwealth Bank of Australia ((CBA)), which rose by 12% and Westpac Bank ((WBC)) increased by 5.8%. All the major banks provided trading updates in May, with lower impairments driving earnings upgrades across the sector.

In fact, every bank in the ASX300 saw FY21 earnings upgraded in May, and rising earnings accounted for 70% of the sector's return last month.

In Morgan Stanley’s view, major bank price earnings multiples can continue to trade above long-run averages given low interest rates, an ongoing earnings upgrade cycle, rising dividends, stronger capital ratios and a lower risk profile.

Technology was the worst performer falling by -9.9%, with a substantial fall for EML Payments ((EML)) of -41.9%, Afterpay ((APT)) -21.1% and Appen ((APX)) declining by -14.4%. On the flipside, Computershare ((CPU)) rose by 10.6%. This is a stock that normally outperforms when bond yields rise, notes Macquarie.

Utilities were also poor performers, with a -4.3% decline over the month. The falls in both the Technology and Utilities sectors were driven more by lower earnings than lower price earnings multiples, explains the broker.

Australian Value, with a rise of 3.7%, outperformed Growth which rose 2.2% in May, with the rise in inflation negatively impacting some long duration growth stocks (e.g. Technology).

While the RBA and the Federal Reserve are currently reluctant to talk about tapering, investors may be favouring Value on the expectation that stocks with shorter duration cash flows would outperform if bond yields spike after a tapering announcement. This occurred in 2013, notes Macquarie.

Where to now?

A continued bias higher in bond yields and the corollary of higher discount rates continues to pressure asset allocation away from growth trades and long-duration positioning.

So whilst the deep value opportunity has largely passed, a broader reflation exposure makes sense to Morgan Stanley. In Australia, this can continue to be played through select Materials exposure, with a laggard opportunity in Energy.

The broker also suggests fiscal policy beneficiaries will likely be supported, while Banks and Diversified Financials also retain Value credentials.

However, a risk to earnings momentum is rising costs, supply chain friction and labour shortages. This environment has been evidenced in global markets and is now a building theme in Australia. Morgan Stanley expects this to feature more prominently in FY21 results, with the breadth of cause, and magnitude of effect, yet to be fully priced-in.

Inflation Fears

While earnings changes were a key driver of returns, the outperformance of banks along with poor returns from Technology and Utilities is consistent with a market positioning for rising bond yields, explains Macquarie. This is despite the fact the bond yields fell slightly over the month.

The market appears to be reacting more to strong inflation data though there is ongoing debate as to the duration of inflation pressures.

The 10% rise in the gold sub-sector is consistent with rising inflation. While the broker believes bitcoin is a risk asset, there are some who believe it is “digital gold”, and so, the -36% fall in bitcoin may have benefitted gold inflows.

Technology

So far a spike in treasury yields has seen a consolidation though not a decline in the Nasdaq. 

US industry technology bellwethers still look solid as forward revenue estimates keep ticking up though multiples are flat. However, if the dotcom era is anything to go by, there appears a lag of rate hikes and stock market declines, notes Credit Suisse.

In Australia, technology share prices underperformed again in May, most clearly in the WAAAX’s, led lower by Afterpay ((APT)). Three out of the five WAAAX stocks were down by more than -10% over the month.

The ASX technology index was down -7% versus the ASX100’s rise of 2.2%. Within the technology index, Bravura Solutions ((BVS)) rose 22%, Praemium ((PPS)) 20% and Bigtincan Holdings ((BTH)) increased by 18%. Meanwhile, EML Payments ((EML)) fell by -42%, IOUpay ((IOU)) -36% and Nuix ((NXL)) declined by -33%.

After checking on WAAAX relative valuations, the broker feels Xero ((XRO)) looks pricey though subscriber growth and average revenue per user (ARPU) sets up well for FY22. The analyst is comfortable looking through the lower-than-expected FY21 margin and FY22 margin guidance, given top line strength.

Also, if Altium ((ALU)) returns to double-digit growth in the June half we could see convergence toward WiseTech Global’s ((WTC)) higher price earnings ratio.

Within Credit Suisse’s technology sector coverage the order of preference among those with an Outperform rating are Xero, Life360 ((360)), Audinate ((AD8)), Altium, Iress ((IRE)) and Infomedia ((IFM)).

While remaining Neutral on WiseTech Global and Appen ((APX)), the broker is skewed more positively towards WiseTech Global than Appen, about which it has more concerns.

Credit Suisse sees multiple companies under coverage with strong, multi-year compounding growth outlooks, which can continue to perform well. Within travel names the broker continues to see upside for Corporate Travel Management ((CTD)) and Webjet ((WEB)), as global travel resumes in late 2021 and into 2022.

REITs

REITs provided a total shareholder return of 1.69% in May, underperforming the ASX200 by -0.65%.

In news flow for the month, the May federal budget had limited obvious impact on the broader REIT sector, suggests Credit Suisse, though increased funding for childcare indirectly provided a boost for childcare landlords.

The Victorian seven day lockdown (since extended to 14 days) might delay the recovery in physical office occupancy and retail patronage in the Melbourne CBD. That said, the market did not appear to aggressively further discount those REITs with relatively high Victorian exposure, though it’s felt it could impact their share price recoveries.

Also in Victoria, a key focus in the upcoming August reporting season may be the effect upon REITs of new stamp duty, land tax and windfall gains taxes.

The REIT sector is trading at an around 68.3% premium to net tangible assets (NTA) on a weighted average basis. Unsurprisingly for Credit Suisse, fund managers such as Charter Hall Group ((CHC)), Goodman Group ((GMG)), Centuria Capital Group ((CNI)) and Home Consortium ((HMC)) are all trading at meaningful premiums to NTA. Alternatively, regional mall-exposed names are still trading at relatively deep discounts.

The fund managers continue to trade on relatively higher funds from operations (FFO) multiples, with pure-play alternative and industrial sector-exposed stocks also trading above the sector average. This latter group includes Ingenia Communities Group ((INA)), Arena REIT ((ARF)), National Storage REIT ((NSR)) and Centuria Industrial REIT ((CIP)).

Also the retail-exposed BWP Trust ((BWP)) is trading at a relatively high multiple, potentially due to defensive and predictable earnings. The diversified Mirvac Group ((MGR)) is also trading on relatively high multiples, perhaps due to expectations of a recovery in its development business as the apartment pipeline is re-activated, suggests Credit Suisse.

Within the broker’s coverage, the equities market is willing to pay a premium for pure-play childcare and industrial exposure, and to a lesser degree, residential exposure.

Outperformers for the month included Arena REIT, which rose 5.9%, Charter Hall Social Infrastructure REIT ((CQE)) 5.8%, Irongate Group ((IAP)) 5.8%, Ingenia Communities Group 5.7% and Hotel Property Investments ((HPI)) increasing by 5.2%.

Underperformers for the month were Home Consortium falling -5.2%, Lendlease Group ((LLC)) -3.3% and Charter Hall Long WALE REIT ((CLW)) declining by -2.0%.

Dividend yields and payout ratios vary across the sector, with those looking at “self-funding” models at the lower end of the payout ratio spectrum and thus, offering lower relative yields.

The Australian ten-year bond yield was fairly stable at around 1.655%, versus 1.69% one month ago.

Credit Suisse has a preference for Fund Managers and Industrial, with Goodman Group the preferred exposure. The broker is also attracted to the large cap diversified’s as a basket, but prefers Dexus Property ((DXS)) and Mirvac Group. 

Within retail, the broker prefers Charter Hall Retail REIT ((CQR)). While not a REIT, there’s also considered long-term value in Lendlease Group for patient investors.

Bonds

US ten-year bond yields remained fairly flat declining by -3.3bps, with falling real yields being offset by rising breakeven inflation. 

In the US, April consumer price index report posted a big upside surprise, with the core reading surging by 0.9%, its largest monthly gain since 1981. A large proportion (over half) of the rise was due to surges in prices for used vehicles, airfares and lodging.

Given the nature of these items, JPMorgan’s US economists maintain that the move higher will prove transitory. This is because supply chain issues eventually will be resolved and travel-related prices will steady after getting closer to pre-pandemic levels.

Commodities

The persistence of negative real yields appears to have finally triggered a move higher in the most sensitive assets, being gold and silver, explains JPMorgan.

Through the month, gold gained 7.8%, which takes the cumulative gain over the past two months to over 11%.

Copper rose by 4.3, nickel climbed 2.4%, while iron ore rose by 14.5%, after retreating slightly from its peak.

Brent Crude rose 2.8% for the month and WTI Crude by 4.3%.

Currencies

The Australian dollar was flat over May gaining only 0.2%, while the US dollar index continued to slide. In the year-to-date, the Australian dollar has gained just 0.4%.

Technical limitations

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