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Since global stock markets began their downward spiral in April, every sector has underperformed the FTSE All Share.
This depressing statistic can partly be explained by the fact that the All Share is a value weighted index and has therefore been disproportionately elevated by the relative outperformance of the largest companies on the market. The 10 biggest stocks in the UK account for 42% of the market capitalisation of the FTSE All Share and nine of them have enjoyed a share price increase in the last year. All but three of the FTSE 100 stocks that are in positive territory in the last year are from the top half of the market which accounts for 80% of the size of the FTSE All Share.
Taking the average performance of the FTSE All Share on an equal weighting, presents a less stark picture of the performance of the individual sectors.
The Energy and Utilities Sectors have held up especially well since the sell-off began, with Industrials and Financials (excluding collective investment vehicles) also managing a decent performance. By contrast, Basic Materials and Consumer Cyclicals have been especially poor performers.
The strength in the energy sector is easily explained by price rises. Supply constraints alongside persistent demand has sent the price of oil and gas soaring and this has been reflected by these companies’ profits. The fact that many of these companies were trading on relatively lowly multiples until late last year has only added to their relative outperformance. While there is no doubt that continued pressure for more renewable alternatives to oil and gas will be applied to the big energy companies, demand is unlikely to dwindle any time soon.
Higher wholesale oil and gas prices should have been hurting the UK’s utilities companies, but the removal of the energy price cap has helped soften the blow and investors have leapt in. The sector’s defensive characteristics might be being questioned by the mainstream media (rising costs might leave many UK residents unable to pay their bills this winter), but in reality, the UK’s listed Utility companies are among the most reliable in a sell-off, helping to explain the sector’s relative outperformance in the year to date.
In a sell-off, investors tend to turn to defensive sectors, which are perceived to be relatively recession proof (healthcare, food and utilities are in demand even when the economy is tanking). But in 2022 the Defensives Super Sector has underperformed.
The Consumer Defensive space is battling inflation concerns which are hammering margins, while Healthcare is still reeling from the confusion of the pandemic. Sensitives - held up by the strength of the Energy and Industrials markets - has topped the Super-Sector roster so far this year.
Switching into Cyclicals to benefit from their bounce-back when the economy recovers is a classic Jim Slater strategy. In his famous book The Zulu Principle, Slater dedicates a whole chapter to realigning a portfolio to benefit from the cyclical recovery.
But Slater also highlights the importance of timing (which has been a well discussed issue among the Stockopedia community amid the current turmoil). Switch into cyclicals too early and you’re likely to feel some pain. We have certainly seen that this year. The Consumer Cyclicals market is down by an average of 27% in the last six months - the second worst performing sector in the FTSE. Only the Basic Materials sector (another cyclical) has fared worse. In the current environment it's important to be especially wary of highly levered cyclicals which might be facing an uptick in finance costs now that interest rates are on the rise.
Slater gives plenty of advice for screening for high quality cyclicals and identifies high institutional ownership, low gearing and high return on capital employed (ROCE) as clear signals that a company in this space could be expected to recover when the markets do. But even if you screen out the junk, be prepared to endure a decline.
The below is a selection of high quality, profitable cyclicals with a trailing twelve month return on capital employed (ROCE) of over 20% and net gearing less than 50%, identified using the Stockopedia screening tool. On average these 30 companies have endured a 28% share price decline in the year to date.
Company | Net Gearing (%) | ROCE TTM (%) | Forecast P/E |
Rio Tinto | -2.09 | 27.69 | 6.15 |
Anglo American | 16.25 | 23.28 | 5.43 |
3i | 6.09 | 29.49 | 5.73 |
Croda International | 14.05 | 24.35 | 25.82 |
InterContinental Hotels | -142.25 | 23.09 | 18.09 |
Hargreaves Lansdown | -85.62 | 45.93 | 16.57 |
Persimmon | -21.64 | 23.12 | 4.91 |
IG group | -57.37 | 20.01 | 8.35 |
Man | 15.38 | 23.63 | 5.92 |
Howden Joinery | 42.13 | 28.99 | 9.27 |
ITV | 37.21 | 20.51 | 4.37 |
Games Workshop | -9.59 | 56.82 | 15.42 |
Greggs | 37.08 | 23.49 | 15.18 |
Ninety One | -3263.54 | 53.25 | 10.44 |
Plus500 | -124.08 | 61.94 | 5.65 |
AJ Bell | -50.49 | 38.56 | 28.26 |
Domino's Pizza | -478.87 | 26.67 | 11.36 |
4imprint | -53.45 | 61.67 | 17.82 |
Ferrexpo | -10.53 | 26.99 | 3.61 |
Integrafin Holdings | -965.38 | 45.52 | 15.14 |
CMC Markets | -47.71 | 24.49 | 11.23 |
Forterra | -3.50 | 28.65 | 9.36 |
Moonpig | -120.90 | 39.53 | 11.61 |
Liontrust Asset Management | -65.89 | 39.02 | 7.21 |
Alfa Financial Software Holdings | -10.98 | 47.83 | 24.52 |
Foresight group | -68.60 | 38.70 | 13.22 |
Molten Ventures | -3.17 | 21.78 | 3.46 |
LSL Property Services | -2.38 | 23.32 | 7.44 |
Capital | -0.93 | 21.76 | 4.71 |
Record | -61.44 | 40.11 | 13.25 |
This suggests there could be some good value opportunities on offer here. Miners Rio Tinto and Anglo American are trading on a forward PE ratio of 5 and 6 times respectively, well below their historic average. High quality operators Games Workshop, Greggs and Domino’s Pizza are trading on multiples not seen for many years. ITV - a former FTSE 100 company - is currently trading on just 4 times forecast earnings.
But to get the timing right we need to ponder what comes next. Will the energy sector continue to outperform? Will the housing market collapse, dragging property, financial and building companies with it? Is there enough innovation in the UK to reignite tech sector growth? Is healthcare as defensive as it once was?
We’ll be digging into those themes in the coming days.
About Megan Boxall
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Great article. It's very important to use equal weighted indices. Most investors split money equally, certainly not according to market value.
Slater is obviously right that cyclicals rebound but how do we know at what stage we are in the cycle? An article on this would be great.
Evidently I'm not one of 'most investors'. What's the point in splitting money equally? And, even if you started out that way, how can you maintain it? I hold stocks where the share price has increased three or four fold during the last few years. They have become disproportionately weighty within my overall portfolio. Sure, I will take profits here and there and trim over-large holdings. But I am not inclined just to walk away from my winners, where the fundamentals remain good, simply because they are winners.
I try to put my money into investments that will outrun the market (always allowing for dividends as well as the basic SP). To the limited extent that I get things right, and as I reluctantly shed the shares that have disappointed me and don't look worth holding long-term, my portfolio has become very unequally-weighted. I see much greater relevance in comparing the performance of my unequally-weighted portfolio against unequally-weighted indices than against a flat evenly-weighted index that actually represents nobody's reality. The ordinarily weighted indices reflect the growth and success of businesses over many years. For me, they represent a much better standard of comparison.
Stocko/SCVR (noting that the latter is 'what it says on the tin') is appallingly biased towards the small-cap segment ... sometimes close to the point it seems to be pimping it. But subscribers (not me!) seem to like it that way.
For the past few months a contrarian strategy focused on betting against SCVR highlighted stocks (both short and long) would, I think, have brought market-beating returns.
Reading between the lines, however, I am still able to glean a little good intelligence to support my broader investment strategy that admits large- medium- and small-caps.
One way or another, I think Stocko is excessively-focused on small-caps (seriously). But the people who pay like it that way.
I agree with Stocko/SCVR bias towards small caps. Most of my holding is not in small caps and since I joined Mello two years ago I have lost a great deal with the rubbish discussed there to the extend I decided not to buy any AIM company.
In the current market the best buys are in the top 350 companies.
I have done reasonably well with FTSE 100 and 250 companies, but I can't say the same for AIM listed, where I have lost around 30% of my ISA portfolio.
I did particularly well with two or three companies in particular, none of which were in AIM.
The 50/200 Moving Average death crosses have been so clearly predictive in 2022, for every distressed stock on my buy watchlist. Given that, I am watching for the turn into golden crosses - and then I will wait a bit longer just to be sure - before gradually buying in to a hopeful upturn [at least for those stocks, if not the markets in general].
Otherwise I am more than 50% in cash, as I can find almost nothing worth buying just now...!
I agree with Lucky Dip, and others, about AIM. But I disagree on what are the 'best buys in the current market'. IMHO there is almost nothing to buy at the moment - but lots of specific, individual stocks to put on a Buy Watchlist for the next 1-2 years, based on a strongly Contrarian stance [which is basically what this article is about]. Even if cash is losing 6% right now, that is nothing compared to the 50-70% undervaluation of most of the stocks I am watching.
Otherwise I have been very long on international coal and hydro carbons since the first day of the war in Ukraine, and that has done very well. The rest of 2022 is pretty much a busy, in my opinion.
*Past performance is no indicator of future performance. Performance returns are based on hypothetical scenarios and do not represent an actual investment.
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Nice to see an analysis of larger companies.