For those carrying cash when a bear market hits, one of the toughest questions to answer is when to start putting that cash to work. With the ASX down more than 30%, and the one year forward price-to-earnings ratio at around 13.6x, it’s starting to look more tempting. However, this is before most analysts have been able to adjust their earnings expectations to account for closures, lockdowns, and quarantines.
So how do you know when it’s time to log back into your online broker? And what should you be looking for when you do? I reached out to three fund managers to get their view on these critical questions. Responses come from Weimin Xie, MX Capital; David Moberley, Paradice Investment Management; and Russell Muldoon, Reqon Capital.
Cyclical value stocks to rebound first
Weimin Xie, MX Capital
It’s very difficult to pick the top or the bottom of a market. Our observation in past cycles indicates that value stocks outperform growth stocks after a crash for the immediate recovery.
In the first stage, cyclical stocks that have been heavily sold off generally do best. For example, Flight Centre is likely to do well from the current coronavirus panic. If you think a stock is absolutely very cheap and will survive, then go for it. Even the market is still falling. Just keep in mind, things can get cheaper. Flight Centre's (FLT) price-to-earnings ratio (PE) was 6x in December 2008, after allowing for large earnings downgrades. FLT's multiple expanded to 11.5x at Dec 2012 and the share price tripled as the GFC passed.
After the initial rebound, quality growth stocks are what will carry your performance well into the next bull market, as long as they’re trading at a sensible valuation. For example, REA Group was still trading at just 18x PE in 2012 at around $14. (Editor’s note: current price is around $75)
Don’t get smelly fingers
David Moberley, Paradice Investment Management
There is a saying about picking bottoms and why you don’t do it. We won’t go into that! However, that saying is a reminder that it’s about time IN markets, not timing markets. So, it’s important to get defensively positioned when the facts suggest you should, but also to keep a flexible open mind and shift your view when the facts change.
In terms of changing positioning and adding risk you want to make sure you are stepping onto a solid platform. If you’ve done your work and have a strategy you can execute without all the noise. There are several signals that can suggest it’s time to start adding risk again. While not exhaustive, here are some examples that are applicable for both stock specific and market risk.
- Technical analysis. Great for showing points of maximum panic and oversold corrections.
- Valuation. Equity risk premium, earnings yield etc. Take risk when you are being paid to.
- Earnings revisions. The market may occasionally get in front of a downgrade cycle, however its normally less risk putting additional capital into the market when the earnings revisions bottom out.
- Other markets. Credit/bonds/currency normally stabilise before equities and show signs of distress occasionally when equities are not.
- External sentiment indicators. Listen to your teammates, competitors, brokers and analysts. Markets are characterised by groupthink and usually the bottom is when the last bull is beaten into submission. Find the most bullish person you know and when they finally capitulate its normally a pretty good indication it’s getting close to the bottom.
Once the volatility settles down, bear markets are a great time to high grade your portfolio and set yourself up for the next few years. The opportunity to buy some of the best businesses in the market at fire sale prices is very attractive particularly where the underlying earnings power of the businesses has not fundamentally changed. The market always pays for peak cycle earnings at peak multiples and trough cycle earnings at trough multiples.
Patiently waiting for the peak of negative news
Russell Muldoon, Reqon Broadcap Fund
‘When America sneezes, the world catches cold’ is the adage that fits best. With that in mind, the situation unfolding is something we continue to watch very closely, looking for an improvement in key data points.
Firstly, and as we mentioned in our prior article, we are patiently waiting for peak negative news flow to be behind us. This is the point where the news flow ceases to be shocking like it has been for the past few weeks. What we’re looking for is a news cycle that becomes more normal with daily reports flowing in a more steady-state fashion and in a form that which we would come to expect at this point in the virus’ lifecycle.
We have been collecting a lot of data, and based on our analysis, we feel we are close to the ‘peak’ with the US starting to see infection rates spike. After the shock that the US does not have things under control (as Trump has been tweeting), we will potentially watch the US shut down. We believe things may begin to settle down as people become less rushed and panicked and begin to deal with what’s in front of them.
Misinformation breeds confusion and distrust, which is what we have had until this point. However, there's not really a lot more that can be hidden from the public now that quality data is starting to flow from credible sources.
Secondly, we would like to see the rate of case infections begin to decline. At present we are headed north at a somewhat alarming rate. But in China we are seeing that rate slow with signs of normality returning.
In saying this, the data from China is highly unreliable. We therefore feel that we need data from other more reliable economic areas such as Europe / France (which has a similar high-quality health system to ours) to be on the improve with lower incremental rates of case growth as a signal that governments have the virus under control. Once that starts to occur, economies can start to look forward to the next steps of opening again. Once we have that logic creeping in, ‘green shoots’ will start to appear.
Thirdly, we want to see panic selling abate, lower volatility and as a result, more-stable index-level and individual share prices. Equities are showing high levels of liquidity stress right now, characterised as lots of sellers with few buyers with wild swings in market prices.
We don’t like any attempt to pick up pennies in front of freight trains so we are standing aside of this chaotic market behaviour at present, waiting to see signs that this equation has begun to balance out. This would indicate that more rational behaviour is occurring. This is likely to occur before the risks to earnings become quantifiable. We do feel that equities have been oversold, an important point to note.
For the second part of the question, our plan for increasing equity exposure (we are 100% allocated to cash assets presently), is two-fold. First, we are planning on seeking very broad exposure to the market and not taking many ‘big bets’ on individual names initially. As the time frame is extended thereafter, the second step will be to more-accurately re-quantify the risks for companies’ earnings and their outlook profiles again. Once that is forecastable, we will then start to seek more concentrated exposure to individual, high quality businesses, as we have done in the past.
And the rest as they say will be history! But… one thankfully we have managed to largely sidestep.
More from this series
- Part 1: Staying in control when the market’s going crazy
- Part 2: What to buy when everyone’s selling
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Great article Patrick!
Enjoyed this article too. Livewire is one of the best resources about. Easy to read but still informative.