A momentum trader’s view of the ASX

Australia’s ASX index, like global peers, is trading a range, with relatively safe sectors like utilities and consumer staples in demand. Woodside Petroleum has strong upside momentum, while airline Qantas Airways looks compelling from a value perspective.

Australian stock exchange building
Source: Bloomberg

The ASX has shown the same concerning pattern seen in equity markets globally throughout August. It has barely broken out of the 5500-5560 trading range through much of the month, despite what has in many respects been quite a disappointing earnings season

 Trading volume in August has by-and-large been much lower than the 100-day moving average. There does seem to be a feeling in global markets that many investors are waiting for everyone to return from northern hemisphere summer holidays to see some direction in markets.

With valuations high, and yields low, we have seen much of the gains in the past week being driven by funds seeking out the more safe-haven-like parts of the market, such as utilities, consumer staples and piling into higher yielding names.

ASX chart

ASX earnings season versus market expectations

With 125/195 companies having reported earnings so far, total earnings for the index have been 12.4% below analysts’ consensus estimates. It’s only the energy and materials sectors that have managed to beat consensus estimates, which does help provide a little fundamental support to their recent rally despite their high price-to-earnings ratio.

ASX chart 2

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ASX chart 2

ASX earnings v. last earnings results

Earnings growth is down 16.3% since ASX companies reported their half-yearly earnings. Unsurprisingly, some of the biggest declines have been seen in the energy and materials sectors, but given a number of these companies also beat estimates there is a feeling that some of the worst of the earnings declines in these stocks may be over.

ASX chart 3

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ASX chart 3

Top 15 winners and losers

GWA Group has been the best performer of the past week after it ended four years of consecutive declines in net profit with its earnings release on 22 August. GWA has diversified its building fixtures and fittings business into more profitable business lines and its earnings are showing the benefits.

Cleanaway Waste Management has seen a similar upside surprise in earnings, which has been warmly welcomed by investors.

Monadelphous Group saw a huge drop after its earnings release failed to live up to the enormous rally going into the results, but it has such a large amount of short interest it could well see a bit of buying as people look to close these positions out.

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ASX valuation

ASX valuations continue to trade at historically high levels. The forward price-to-earnings ratio on the ASX is sitting at 17.1, still almost 1.5 standard deviation above the long term average for the index.

ASX chart 5

Sector returns

US dollar gains have been capped heading into the Jackson Hole Symposium, and this has been a huge driver for commodity prices over the past week which has helped materials stocks see one of the strongest performances in the index. But the other interesting development is investors rotating back into some safe haven sectors, such as utilities and consumer staples. The unnaturally low volumes and low volatility we are seeing in markets does appear to be driving some investors to hedge into some of these safe haven sectors.

ASX chart 6

Factor returns

Alongside this is a very interesting surge in high yield stocks. High yield stocks returned 1.6% over the past week and 5.9% over the month. This seems to show that in this very low volatility environment investors seem happy to just pick up yield where they can rather than piling into momentum stocks in the hope of capital gains.

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Value screens

I’ve tweaked Joel Greenblatt’s ‘magic formula’, which is earnings yield (earnings divided by price) times return on invested capital. I’ve ranked the stocks in the ASX 200 according to their Z-score, which is a reflection of their position according to the Gauss normal distribution.

The key takeaway is that Qantas continues to look like a compelling value buy even after its strong earnings result, as it has both strong earnings and is relatively undervalued and has now committed to paying a regular dividend.

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Momentum Stock Picks

Note: These momentum stock recommendations are based on backtested results looking at a three-five day holding period with a 5% stop loss on every trade.

Woodside Petroleum

Woodside has continued to gain alongside the rally in oil prices and the solid work it has done in shoring up its balance sheet during the massive sell off in the oil price over the past two years. With oil prices firming up between the US$45-$50 level, the stock looks set to hold up well.

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