Which companies are Leading the Market Recovery?

A +15% rally in the ASX one month after the markets bottomed, has not been shared equally across the markets. The smallest companies have run the hardest, along with Technology companies, while the Blue-chips and Bank shares have been left behind. Let’s explore the differences between the winners and losers.

Note: we’re not stating that the market has bottomed in this cycle. Statistically, the lows are likely to be re-tested in May, which is just around the corner. Nonetheless, there are reasons some have run harder than others since the late March lows.

Who is winning the rally?

1. Information Technology companies are up +41%. Driven by Xer0 (XRO), AfterPay Touch (APT) and Computershare (CPU) as the heavyweights.

2. Energy is up +29.7%. Put into context, Energy shares have been hit much harder than the rest of the markets. Oil received its own Black Swan event with disputes between Russia and OPEC leading to dramatic spot oil price falls. This group is best seen as coming off a very low base.

3. Property / AREITs are up +25%.Property owners are still bringing in the rent payments. Bond prices went out the window with equity prices a month ago, a flurry of volatility that bonds should not exhibit, but clearly have. Property prices are expected to fall, although not to the extent that the listed property trusts (LPTs) have. Long term, conservative buyers are lapping up the opportunity to buy these shares at ‘generational lows’.

Which companies are being left behind?

1. Consumer Staples (Grocers) +3.3%. The supermarkets barely fell as the COVID-19 panic rushed the markets and grocery shelves as it was. Given these shares didn’t fall much, there is not as much to ‘recoup’ and that shows in this month’s performance

2. Telecommunications +6.3%. Telco companies also held up reasonably well as the markets fell. Buyers took safety in the knowledge that everyone at home would be streaming live news feeds and entertainment content. If there was one bill those in lockdown would pay, it would be the internet bill. These companies performed like sound utilities and showed much less volatility and price vulnerability, now showing in relatively lower performance this month.

3. Financials - namely Banks + 11.6%. For some time now, I’ve been an advocate for stating that the banks’ domination in the Australian market has had its day. 2015 was the peak, when everyone who owned banks was an investment genius. Just as Fairfax and Newscorp dominated the markets in the late 1990s, these banks have had their day.

2020 is showing that the rest of the market is recovering, and the banks are being left behind.

Why are Banks being left behind?

Here are just some of the headwinds facing Australia’s banking shares:

1. They are criticised for being able to pay dividends when the country and world are expected to enter recession

2. They are unable to provide the loans the federal government has requested they issue to the Australian public and companies. Whether the issues are globalisation of the workforce that is in lockdown (risk teams in India), or administrative tasks outsourced to countries limiting working hours, have hindered their ability to meet demand.

3. Changing eligibility criteria to borrowers buying homes with pre-approved loans. Suddenly their industry of employment is deemed risky and the bank they thought was supporting them has walked away from the settlement of their new homes.

4. Landlords not being allowed to kick tenants out and ‘mortgage holidays’. Suddenly the federal government is dictating how banks manage the risk on their loans. While it’s not nationalisation, it’s a lot more regulatory involvement that we all would have imagined only a month or two ago. A swift intervention from the regulator is rarely a welcomed investment environment.

All of these issues are making investment in banks less appealing, and hence the share prices are wallowing near the lows, while the rest of the market seeks higher levels. This marks the end of the banks’ dominance in Australia. Only a few years from now we will have new, defined leaders on the ASX.

This is not to say that the banks will fall off a cliff - that’s unlikely. What’s more likely is that the banks slowly drop down the market rankings like the media companies have in the decades that have passed. Still household names, but less prominent in the gyrations of the overall Australian share market.

Blue Chips vs Small Caps

To extend the issues of the banking shares is their prominence in the blue-chip space of the ASX. Banking shares still make up ~30% of the index, so it’s difficult for the AU market to rally without banks - although this month shows that it is possible.

Because the banks have been a dead weight on the ASX, the blue-chip shares, or ASX Top 20, are only up +12.1%. However, the smallest group, the Emerging Companies are up an astonishing +47%.

The Emerging Companies were hit the hardest in the falls, apart from energy companies (see above). These companies normally have less stable balance sheets and less institutional investor support.

When times are tough, like they are now, companies might need to raise money by selling shares. This is especially the case when the companies have little cash reserve and their revenue stops (such as travel and restaurants in COVID-19 lockdowns). In these desperate times, desperate discounts are offered to new share buyers for new shares issues. New shares issues on these terms are extremely dilutive to the existing shareholders, and thus terrible for share prices.

Once these small companies have been through their financials and reported on the impacts of COVID 19, they can announce their strategy to market. If that involves raising money, the share price might fall further. However, those that have confirmed to market that their balance sheet is strong, have rallied +100% or more.

These strong companies with strong rallies are why the small end of town has eclipsed the big end of town.