During periods of crisis, top-down macroeconomic issues tend to drive stock market returns more than company-specific factors. The surprising conclusion of Credit Suisse’s latest market outlook is that investor focus on macro drivers is currently at extreme levels, even though we are not in a financial crisis.
Credit Suisse analysts Hasan Tevfik and Damien Boey estimate this by measuring the correlation of returns between stocks. When returns are moving more closely together, they are usually driven by a handful of macro factors such as global growth worries or attention to central bank rate decisions. When correlations are low, individual factors such as profit outlooks and balance sheet strength are given more weight.
Chart: ASX 100 intra-market stock return correlation
Source: Company data, Credit Suisse estimates
Returns are more highly correlated across the market now than during the global financial crisis or the Asian currency crisis.
The fact the equities market has flirted with bear territory this year, collapsing 18 per cent from its April peak to late September trough, despite an economy that continues to grow modestly, implies there are individual stories of value to be dug up.
“Investor focus on top-down drivers has never been as great as it is now. However, history suggests these periods have tended to be fleeting,” the analysts say.
“We think it is time for investors to be contrarian and we think it is time for investors to think more bottom-up.”
That advice might be tough to heed, given economic headwinds have returned to the fore. Employment growth slowed in September, while worries about a housing slowdown got a fresh boost courtesy of an out-of-cycle rate hike from Westpac that could threaten already shaky consumer confidence.
Credit Suisse are not the only contrarians now urging investors not to run with the crowd.
Contrarian investors look for stocks they believe have deviated from intrinsic or fair value, often because they have been buffeted by macro headwinds that put them temporarily out of favour.
Not all companies that are out of favour are bargains though, as Chad Padowitz, chief investment officer at Wingate Asset Management, points out.
Padowitz says the key is assessing whether a company’s share price has fallen due to structural or cyclical factors. A company in structural decline because of disruption (Nokia, Motorola), the rise of low-cost competitors or its place in a sunset industry like tobacco or coal should be avoided.
“Where we see opportunities are in the shorter-term, non-structural factors,” Padowitz tells clients, citing macro themes such as interest rates or commodity prices that may have hurt demand, price or sentiment towards a stock.
Those temporary deviations from fair value throw up the sort of opportunities that Credit Suisse identifies.
Valuations of Australian stocks are cheaper than at the start of 2015, with trailing price-to-earnings ratios in line with long-term averages, while dividend yields are verging on 5 per cent -- previously a good time to buy, Tevfik and Boey say.
They went looking for stocks that have suffered top-down headwinds but have attractive bottom-up characteristics, including reasonable valuations, solid balance sheets and efficiency in generating free cash.
Their list includes property market plays CSR, Lend Lease and Boral; consumer stocks Nine Entertainment, Fairfax, Harvey Norman and Flight Centre; the four major banks and stocks sold-off on Chinese growth worries including BHP Billiton, South 32 and Iluka.
Conceding they were too bullish on their index targets this year, Credit Suisse’s analysts now expect it will take till the end of 2016 for the ASX 200 to recover the 6,000 mark, which implies a 15 per cent capital return and 20 per cent total return.
Wingate’s Padowitz argues there are added benefits to contrarian investing because it avoids momentum trades and insulates investors from known behavioural finance traps such as becoming overly attached to a rising stock.
“If you can remove yourself further from the biases of fear and greed, you can allow the underlying fundamental valuations and intrinsic value to come through,” he says.