Why this is the most hated bull market

The first six months of calendar 2019 have again superbly proved as to why this equities bull market has been dubbed "the most hated in history".

At face value, equity markets have rallied by up to 20% suggesting making money from asset price inflation via the share market has seldom been easier for investors, but a closer look reveals nothing could be further from the truth.

Imagine an investment portfolio consisting of Adelaide Brighton, Bank of Queensland, Challenger, Caltex Australia, Domino's Pizza, Flight Centre, Link Administration, Pendal Group (the old BT Investments), South32 and the old Westfield, now Unibail-Rodamco-Westfield.

An equal weighted portfolio of these ten household names in Australia generated a negative return of nearly -10% between January 1 and June 28. That's ex-dividends, but the average yield from the portfolio cannot fully compensate for the erosion in capital values. Besides, the ASX200 Accumulation index is up nearly 20% over the same period.

And that's assuming investors venturing into some of the riskier stocks on the ASX haven't been caught out by disasters experienced by Syrah Resources (down -39%) or Wagners (-42%) or Bionomics (-72%), and numerous others.

Many a self-managing investor has portfolio exposure to the big four banks, large resources and energy producers, as well as Telstra, Woolworths, and Wesfarmers-Coles. They don't necessarily need to compare their performance with a benchmark, so they most likely are feeling happy with the Big Bounce post the Grand Sell-Off during the closing months of 2018. In particular if they also managed to pick up some additional gains from smaller cap highflyers such as Afterpay Touch, Austal and Credit Corp.

For professional fund managers, however, the scenarios for share markets in 2018 and the first half of 2019 have made beating the index an extremely tough challenge; indications are most have continued to underperform. This, mind you, at a time when ETF providers offer ever cheaper alternatives and most retail investors would feel emboldened about their own talent and capabilities too.

It should thus be no surprise that, with the notable exception of Magellan Financial ((MFG)), most listed asset managers have been relegated to the basket of consistent underperformers on the ASX, with shares in Janus Henderson ((JHG)), Platinum Asset Management ((PTM)), Elanor Investors Group ((ENN)), K2 Asset Management ((KAM)), Pinnacle Investment Management ((PNI)), and others overwhelmingly in the doghouse at a time when most investors feel like celebrating.

Internationally, the first signals are becoming apparent the industry of actively managed investment funds is ripe for consolidation, or otherwise a shake-out. Locally, all major banks with exception of Westpac ((WBC)) have unveiled plans to divest their wealth management operations, while Magellan Financial acquiring Airlie Funds Management and Ellerston Capital acquiring Morphic Asset Management are but two early indications the industry locally is equally facing major transformation in the years ahead.


But why exactly is it that most active managers cannot beat their benchmark?

One narrative that has been going around recently is that investor exuberance is largely to blame. With stocks like Afterpay Touch ((APT)), Appen ((APX)) and other smaller cap technology stocks up 100% and more in the space of only a few months, the narrative goes that institutional investors cannot own these stocks as they are trading on valuations that can never be justified, and with these kinds of share price gains, it makes beating the index a near impossible task.

Sounds plausible, yes? Except that it doesn't stand up to the test of deeper analysis.

Everyone familiar with the major indices in Australia is aware that Financials make up more than 30% of the ASX200 (of which the Big Four Banks more than 20%) while Materials + Energy adds another 23%. Combined these sectors represent more than 50% of the index. Add a few extra large cap names such as Macquarie Group, CSL, Telstra, Woolworths and Wesfarmers and the index representation rises above 66%.

In most years, underperforming or outperforming against the index is determined by how these large cap stocks perform versus exposure in investment portfolios.

But let's first tackle the misguided narrative mentioned earlier.

The WAAAX stocks as a group, comprising WiseTech Global, Afterpay Touch, Appen, Altium, and Xero, represent a total index weight of 1.58% as of June 1st. The average gain from these five stocks is a smidgen over 80%. However, Fortescue Metals ((FMG)) alone weighs 1.35% and its shares went up by more than 117%. Plus Fortescue pays a big dividend and the WAAAX stocks don't.

In other words: Fortescue Metals shares have contributed more to the index gains than all of the WAAAX stocks combined. That's one myth gone.

This example does, however, further highlight one of the key characteristics of the local share market in recent years: the internal polarisation is enormous. The gap between winners and losers is extremely wide and both baskets contain plenty of household names each. It makes outperforming the index not only a case of picking enough winners; it's equally about avoiding the losers (see also portfolio mentioned at the beginning of this story).

This, of course, is more easily done with the advantage of hindsight. With most professional funds managers in Australia practicing a value-oriented approach, owning share market disappointments is pretty much par for the course. This year in particular, as corporate profit warnings have come out in large numbers throughout May and June.

Making matters worse, most managers have been running their funds with larger-than-usual allocations to cash and, certainly up until recently, an underweight exposure to the banks. The latter has proved unequivocally beneficial in years past as the banks underperformed the broader share market. In 2019, however, the banks have staged a notable come-back on the back of a surprise Labor election loss and the promise of RBA rate cuts.

And yet, for the six months to June 30th, the performance for the banks has not kept up with the ASX200 Accumulation index. Even if we exclude National Australia Bank ((NAB)), lagging once again, the Big Four Banks combined, and including above-average dividends, slightly underperformed the index.

Which leaves us with large cap resources stocks. BHP Group ((BHP)) shares added 21%-plus ex-dividend, which is better than the index, but Rio Tinto ((RIO)) rallied 32% ex dividend and shares in Fortescue, as mentioned, more than doubled. In the Energy sector, Woodside Petroleum ((WPL)) narrowly underperformed the index including dividend, but Santos ((STO)) shares went up by 29.43%.

What these numbers show is that underperforming or outperforming the local index over the past six months has been determined by a few large cap stocks only. In particular if we consider that Woolworths and Wesfarmers equally did not keep up with the index. In their place, large cap names Amcor ((AMC)), Brambles ((BXB)) and Telstra ((TLS)) - probably best described as "comeback stocks" - all posted stronger than average gains.

Add Aristocrat Leisure ((ALL)) - up 43% ex-dividend, Goodman Group ((GMG)) - up 37% ex-div, Transurban ((TCL)) - up 25.5% ex-div and Newcrest Mining ((NCM)) - up 51% ex-div, and it is clear most of the strong index gains this year occurred on the shoulders of no more than ten large cap stocks in Australia.

The most outstanding themes have been iron ore, gold, lower interest rates and bond yields, and structural growth stories in the case of Aristocrat Leisure, Goodman Group and the WAAAX companies. At the same time, less confidence and more investor caution has swung the market pendulum heavily back in favour of the large caps, both here as well as internationally.

Note, for example, the Small Ordinaries index barely scraped in a positive return for full financial year 2019, and only if we include paid dividends, for a total return of 1.92%. Over the past six months, the Small Ordinaries' total return was 16.81%. The Top 20 gained 26.72% ex-dividends. CSL too performed strongly, but equally could not match the index. Scentre Group ((SCG)) is responsible for the sole negative performance among Top 20 stocks.

The negative performance for stocks including Scentre Group and UR-Westfield contrasts sharply with the market beating performances for Goodman Group and Transurban. In prior times, all four would have been considered beneficiaries of lower bond yields. This time around, however, investors are excluding the structural challenges from online competition and household budgets under pressure, testing the patience - and frustration - of your typical value hunters in the share market.

After five years of notable neglect, value stocks have made a sharp comeback post late 2018 sell-off, as witnessed by (some) bank stocks in Australia, and via equally selective names among media companies, consumer oriented businesses and resources stocks. Meanwhile, the lure of disruptors and new technology-driven business models has not disappeared.

The latter remains equally one of the key characteristics of this hated bull market. Hated by you know who.

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