The mining sector
With an overall return of over 200%, the mining companies emerge as the stars of the year. In January and February they inhabited a world of overproduction of metals, increasing debt burdens and a dangerous ‘race to the bottom’ in terms of asset sales.
From February onwards, however, sentiment seemed to turn. Whether this was due to record low valuations that made the sector cheap by historic standards, or hopes of increasing demand in key places such as China, or a cut back in production that helped lift commodity prices off their lows is not clear, but the sector turned a corner in Q1 and never looked back.
The big question now is where the rally goes from here. The sector is no longer in the market’s ‘bargain basement’ section, but even now valuations are not too demanding. Crucially, president-elect Trump’s stimulus programme could offer the chance for more gains, as US demand for metals rises. Plus, dividends are making a return, so we could see further investor inflows to help compensate for those that may be selling out now the fire sale in major names like BHP Billiton, Rio Tinto and Anglo American appears to be over.
Oil and gas
A similar story prevails here. In Q1 oil was ostensibly headed for $10 a barrel (according to the same strategists that now expect it to hit $75). Oil majors and a host of smaller firms looked like a bad bet. Then, talk began to circulate that OPEC would begin to do something to curb record output levels. Plus, the US dollar, which had risen sharply in the final months of 2015 on expectations of several US rate rises, began to move lower, as the chances of monetary policy tightening receded.
To be fair, oil prices at $50 do not offer the fat profits enjoyed by the sector a few years ago, when the price was above $100, but a sector that was pricing in disaster 12 months ago is now looking much healthier.
Although the overall index is only down 4%, that conceals the tough year that homebuilders have had. One year ago the sector was enjoying a rally that had endured for several years, helped by rising house prices and solid demand. Yet the signs of cost inflation were there, and valuations were looking decidedly overstretched. Then came Brexit, and the share prices of some big housebuilders lost upwards of 30%. Since then, they have recovered, but remain well off the highs.
Housebuilders currently trade on forward valuations that are, to say the least, undemanding. Throw in decent dividends and the strong land banks that many possess (meaning they will not be required to purchase land for new-builds for some considerable time), the overall outlook seems robust. There are concerns about house prices and affordability, but with demand still healthy the sector offers an interesting value proposition into 2017 and beyond.
Real estate investment trusts (REITs) have fallen by over 12% this year, and again Brexit is to blame. The sector was loved for its yield and the clear strengths of the UK, and the City of London in particular, as a business and finance hub that would keep demand for office space strong. Brexit shook that view, especially as some property funds began halting redemptions. Suddenly investors began to worry and demand for office space would flag and that dividends would fall.
To be fair, that has not come to pass, but investors seem reluctant to return to the sector. While UK economic performance has been good since the vote, there is a sense that the real problems of Brexit have yet to surface, and so income hungry investors have looked elsewhere. Plus, the rise in bond yields has reduced the relative attractiveness of the sector. It still looks relatively cheap, and on this basis (combined with still decent yields), investors shouldn’t ignore it entirely, but the uncertainties of Brexit will deter more than a few.