In May CSL shares were trading at decade lows. An Australian global success story that has compounded earnings for decades was suddenly being treated by the market as damaged goods. Its enormous bounce since then without a significant change in business fundamentals, and the speed of the shift in sentiment, says more about how markets behave today than it does about CSL itself.
Global activity remains resilient, though a slowdown should be evident over the next year. Spending by higher income earners and the build out of artificial intelligence infrastructure are key support areas. Company earnings are strong, but not uniformly so. Challenges include higher energy costs, bond yields and cash rates.
Consumption in Australia has been holding up despite depleted consumer sentiment. However discretionary spending is likely to be constrained by higher interest rates and a drift higher in unemployment. Interest rate sensitive sectors are likely to be under greater pressure than those benefiting from data centre and other infrastructure investment.
In the Australian share market a large dispersion in valuation remains. Some of our larger companies appear expensive, such as in banking and resources, sectors, while several higher quality names are being overlooked.
Market short-termism is being exacerbated by the uncertain macroeconomic landscape as investors gravitate to familiar, liquid names delivering decent results now rather than those that may have a longer term or less certain payoff. A widening gap between price and underlying value is evidenced for several companies with sound long-term fundamentals but less certain short-term news flow.
Patient international fund managers with a longer investment horizon are using this dislocation to take over infrastructure entities like Qube and Atlas Arteria, drawn to their reliable inflation-linked earnings streams. Quality cash generators like Steadfast Group and Reliance Worldwide are also in their sights, businesses with resilient demand, pricing power, and strong free cash flow conversion that the broader market appears to be undervaluing amid the current bout of macro-driven uncertainty.
Volatility is likely to stay elevated because of the growing dominance of value-agnostic passive investing and quant funds which means company news that even modestly varies from expectations can trigger wild share price swings. This dynamic creates risk and opportunity for active and fundamentally focused investors. Adverse sentiment can drive share prices well below intrinsic value while positive re-ratings can happen once confidence is restored, rewarding investors with the conviction and patience to look through the noise.
Blood plasma products producer CSL’s share price action over the past year is an example of this dynamic. The market had largely given up on the stock after a series of earnings guidance downgrades drove significant share price losses. Its full-year result, released in August, was broadly in line with expectations, but guidance for the new financial year surprised on the upside. This triggered a sharp rally, including a rise of almost 40% in August alone, as active fund managers correcting underweight positions were followed by positive quant and passive flows.
Key equity sectors have contrasting outlooks. Bank share prices continue to overstate prospects for subdued earnings expansion driven by modest loan growth, slightly lifted net interest margins helped by higher cash rates and a mild rise in bad debts.
In contrast, industrials sector businesses are fertile ground for portfolio construction, particularly those that are most adaptable and able to utilise new technologies to strengthen competitive advantages.
Upside remains among healthcare stocks that the market had recently almost given up on, with durable demand from the aging population.
The heavily sold-down listed real-estate sector offers investment opportunities despite the headwinds from higher interest rates. Landlords are benefiting from the low level of new supply and ongoing population growth, supporting high occupancy levels and solid rent increases.
Opportunities also exist among technology firms with unique data sets and deep embedding in industry-specific workflows that have been swept up in indiscriminate AI-disruption selloffs.
Consumer-facing businesses outside of expensive supermarket retailers are offering more value after recent selloffs but there is chance of a further leg down if rates rise more than currently priced in by the market.
With equity returns likely to be constrained by full valuations across many areas, yield from robust cash generating businesses becomes increasingly important. Domestic interest rate sensitive businesses with little pricing power will find the road tougher in the period ahead.
For investors with the patience to look through the noise, market dispersion is where the opportunity lies. Not in the crowded, fully priced areas of the market but in fundamentally sound businesses being overlooked because of their temporary misalignment with market sentiment.
General information only and not personal financial advice.
