Déjà vu or a New Paradigm?

September Monthly CiN-sights

Despite ongoing concerns on the outlook for global economic growth and employment courtesy of the coronavirus pandemic, geopolitical risks and the impending US election, appetite for risk assets particularly in the US, continued unabated through August. Even with the current US Q2 reporting season experiencing the largest year-over-year earnings decline (circa 34%) since 1Q2009 during the GFC, records in that market continued to be broken.

Similarly the mid-year ASX reporting season has seen more earnings expectation “beats” than misses, albeit based on what would now seem to be analyst’s overly conservative forecasts. Whilst at the headline level that may seem a positive, we will still experience an approximate 20% YoY fall in EPS for FY20 and consensus for FY21 is only a modest single digit percentage rebound.

Equity markets are continuing to adopt a “look-through” mentality with many trading at or near historic valuations, supported by essentially zero interest rates. The ASX200 forward PE valuation of 20x is now at its highest levels in over 30 years. In the US both the S&P500 and NASDAQ indices have hit new all-time highs and have wiped out all losses from the initial COVID induced market collapse. The amazing rally in the US from its March lows was the end of the fastest bear market in history, and now sees the S&P500 trading on its highest PE since the dot-com bubble levels of 2000.

A key observation in this S&P500 rebound is not only the pace, but importantly the lack of breadth and dispersion of the market move. The largest five stocks (all mega-cap tech stocks) now make up approximately 25% of the index, with the next five stocks accounting for only 6.5%. This narrow breadth highlights what is driving the market, but also illustrates that the majority of stocks are still to achieve their previous peaks.

In the 2000 Tech Bubble the 5 largest stocks in the S&P500 accounted for 18% of the index and the top 10 weighting briefly spiked about 25%. Cynically one wonders whether this sense of Déjà vu is warranted, given history has shown limited market breadth has signalled a number of previous market corrections over the last 30 years.

(Source: Morningstar Direct)

We don’t doubt that quality technology companies will continue to prosper in this apparent “new-normal – work from home” world in which we live, but we are nevertheless cognisant that markets do historically experience a reversion to the mean. With major central banks maintaining near zero interest rates and infusing the system with liquidity, the enthusiasm of investors (institutional, retail and Robinhood traders) towards risk assets and these growth companies may well continue. However, the value versus growth conundrum will rattle on, as will the focus on fundamental valuations. 


Fund Manager Update

Top of the Pack

In this edition of the monthly C-insight we present our analysis on Lennox Australian Small Companies Fund; our preferred domestic small cap manager in the Fund of Funds portfolio and a ‘Highly Recommended’ product on Lonsec.

We have been monitoring Lennox’s performance, since the March equity market correction and have observed positive trends in recent months. Over the month ending Jul-2020, the S&P/ASX small cap accumulation index returned 1.39% outperforming the S&P/ASX100 by 0.9%. All funds in our sample boasted positive returns; Lennox outperformed the group and the benchmark with a 4.46% and 3.09% total and active return respectively.

Key contributors to portfolio returns were the buy-now pay later stock Sezzle, portfolio administration provider HUB24 and data centre operator NextDC. The largest detractors from performance were service station operator Viva Energy, iron ore miner Mineral Resources and diagnostic imaging company Capitol Health.

Pleasingly, Lennox’s performance has been resilient over the longer-term durations also. Over the 6mth, 1yr and 3yr durations Lennox has significantly outperformed its peers and the benchmark index, generating active returns of 4.50%, 1.90% and 3.33% respectively.

The small cap sector is forecast to have stronger and more stable earnings growth than its larger counterparts in FY2021. As such, and given Lennox’s robust performance record we remain optimistic about buoyant future returns.

Lennox adopts a longer-term view on investment ideas, which is prudent given the long-term and unprecedented implications of the pandemic on business models and the rapidly accelerating structural changes in the industry. The fund is supported by a well-structured and repeatable investment process, and a high-quality investment team possessing a strong track record together.   

(Data as at 31 July 2020, Source: Lonsec)
(Source: Lonsec)

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