February In Review: Mid-Caps Are King

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The ASX200 gained 0.8% in February on a better-than-feared reporting season and prospects for declining interest rates and tax. Mid caps and small caps outperformed.

-The ASX200 gained 0.8% (total return) in February
-Technology and Discretionary gained, while Gold and Energy lagged
-Growth outperformed Value, mid caps fared best
-Results season helped form an earnings base, in Morgan Stanley’s view

By Mark Woodruff

The ASX200 gained 0.8% (including dividends) in February and closed the month at a new record high, as inflation in January remained steady at the lowest level since November 2021.

Not only are investors said to be looking forward to cuts for domestic interest rates and government tax, the results season generally might be categorised as better-than-feared.

Still, Australia's sharemarket underperformed relative to overseas indices. In a broad measure of global equity market performances for February, the MSCI All Country World Index (ACWI) rose by 4.7%. The S&P500 in the US gained 5.34%, bringing the year-to-date gain to 7.1%, behind Japan which has gained 14.4% so far in 2024.

Combining a sluggish economy plus a lagging macroeconomic policy response with stretched valuations makes Australian equities unappealing in relative terms versus other key developed markets, in Morgan Stanley's view.

Australian 10-year bond yields rose by 12bps over February to 4.14% and the US 10-year treasury yield lifted by 34bps to 4.25%.

The Technology and Discretionary sectors on the ASX gained 19.7% and 9.7%, respectively, with the Technology sector taking its lead from offshore returns, suggests Morgan Stanley. The Nasdaq100 index in the US gained 5.4% in February for a total return of 51.1% over the last twelve months.

Resources trailed Industrials across all size-based indices on the ASX. The Gold sector lost -7.1% due to rising yields and a stronger US dollar, explains Macquarie, while Energy lost -6% despite a higher oil price in February.

The ASX20 large caps fell by -0.4%, notes Morgans, as shares in heavyweights BHP Group ((BHP)), Woodside Energy ((WDS)), CSL ((CSL)), Telstra Group ((TLS)) and Woolworths Group ((WOW)) fell between -5-9%. The broker attributes the sluggish performance by this index to political risks for Supermarkets, a tepid growth outlook for Banks, and above-average valuations (ex-Resources).

The bigger story in February occurred outside the larger stocks. Small caps outperformed large caps, yet mid caps proved the superior performers in gaining 5.3% during the month.

The Small Ordinaries Index in Australia gained 1.7% in February, led by strong returns within Discretionary, Technology and Industrials, while performance was weighed down by Energy and Materials

In terms of contribution at a sector level, Morgan Stanley notes Financials covered losses within Resources, with some help from Discretionary and Technology.

Growth outperformed Value in February due to stronger results for Growth-style companies in the reporting season, explains Macquarie.

BHP Group was the largest detractor from broader market returns in February. Wesfarmers ((WES)) added the most value, notes Morgan Stanley, followed by Westpac ((WBC)), Goodman Group ((GMG)), ANZ Bank ((ANZ)) and National Australia Bank ((NAB)). Technology was supported by the performances of WiseTech Global ((WTC)) and Xero ((XRO)).

Since announcing results, Morgan Stanley highlights the top three performing stock prices relative to the market were Audinate Group ((AD8)), Appen ((APX)) and Lovisa Holdings ((LOV)), while the bottom three were Seven West Media ((SWM)), Healius ((HLS)) and Corporate Travel Management ((CTD)).

The CRB Index rose by 1% to 275 over February, with Brent crude oil rising by 3.1% to US$83.6/bbl, while the iron ore price fell by -11.7% to US$117/t.

The price of gold rose by 0.2% in February to around US$2044.3/oz.

The US dollar Index (DXY), a measure of the value of the US dollar relative to a basket of foreign currencies, increased by 0.9% to 104.15, and the Australian dollar fell by -1.1% to US$0.6500.

Morgan Stanley observes market earnings have been revised modestly lower during February, though believes a base is being formed for earnings and the result season was a catalyst in that foundation.

The trend to guidance upgrades that began during the AGM season continued in February results, notes Macquarie, and may extend to the August reporting season.

This broker, however, points out aggregate EPS forecasts are broadly similar to when reporting season commenced (for no net change overall, which is a positive as earnings forecasts tend to fall during reporting seasons in Australia).

Based on inflation trends, Macquarie expects interest rate cuts will occur in the US before being enacted in Australia, where ASX cash rate futures currently assign a 10% chance the Reserve Bank of Australia will cut the cash rate to 4.10% from 4.35% in March.

ASX100 Best and Worst Performers of the month (in %)

ASX200 Best and Worst Performers of the month (in %)

ASX300 Best and Worst Performers of the month (in %)

ALL-TECH Best and Worst Performers of the month (in %)

All index data are ex dividends. Commodities are in USD.

Australia & NZ

The World

Metals & Minerals

Energy

REITs

Jarden notes FY24 guidance across the REIT sector is largely unchanged after the February reporting season, but earnings momentum is set to improve with interest rates close(r) to cycle peaks.

The Australian 10-year bond yield and the bank bill swap rate (BBSW) curves have stabilised in recent months, points out the broker, though cap rates may still have further to rise after moving up by 61bps for the sector (from the trough) driving downward pressure on asset values.

The analysts assume a further 20-50bps of cap rate expansion and note every 50bps rise impacts net asset values (NAVs) by around -10%.

The strongest growth momentum is in the manufactured housing estates (MHE)/land lease communities (LLC) asset class, according to Jarden, while growth for the asset fund managers is mixed and difficult to forecast.

For passive REITs, the broker sees the strongest growth momentum in storage and childcare.

In recent years, most REITs have been more focused on balance sheet management and protecting earnings, rather than a more proactive growth strategy, explains Jarden. Now, some management teams can take back control of their strategy and execute on growth initiatives.

The top four REITS in a position to proactively drive growth, from those under coverage by the broker, are National Storage REIT ((NSR)), HMC Capital ((HMC)), Lifestyle Communities ((LIC)) and Goodman Group ((GMG)).

Australian Banks

The average major bank total shareholder return of 4.6% in February outperformed the 0.8% return from the ASX200.

While CommBank ((CBA)) shares performed in line with the ASX200, Westpac, National Australia Bank and ANZ Bank gained 9%, 4.6% and 3.8%, respectively.

Among the smaller banks, Judo Capital ((JDO)) outperformed with a 5.5% gain. Bendigo & Adelaide Bank ((BEN)) gained 1.5%, while Bank of Queensland ((BOQ)) lost -2.8%.

Relative to the ASX Industrials ex Banks, and relative to bonds, Morgan Stanley considers the major banks are expensive compared to the sector average valuation since 2010.

Australian Financials Ex-Banks

Morgan Stanley notes Financials Ex-Banks only slightly outperformed the 0.8% gain for the ASX200.

Both AMP ((AMP)) and Insignia Financial ((IFL)) beat the broker's forecasts for costs during the reporting season and shares rose by 20% and 11%, respectively.

Suncorp Group's ((SUN)) shares also rose by 10%, highlight the analysts, after management noted progress for the sale of the bank operations, and delivered on pricing and volumes in first half results. It's felt QBE Insurance ((QBE)) displayed ongoing reporting consistency and shares rallied by 9%.

On the whole, Asset Managers underperformed, but GQG Partners ((GQG)) shares jumped by 19% in February on a strong FY23 performance, according to Morgan Stanley.

New Zealand

Across the Tasman Sea, the NZX50 in New Zealand fell by -1.1%.

S&P Global notes small caps continued to struggle.

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