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Four industries flourishing under Warren Buffett’s dark economic clouds

Tuesday, March 21, 2017 16:00
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There’s a typically fearless comment in Warren Buffett’s latest letter to Berkshire Hathaway shareholders, where he says:

“Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it’s imperative that we rush outdoors carrying washtubs, not teaspoons.”

Buffett was referring to the sorts of buying opportunities that come up when markets face turmoil. Seismic setbacks in 2000-02 and 2008 are classic examples – but they’re not the only ones.

Last year’s decision by the UK to leave the EU now looks like a pothole for equity prices rather than the type of collapse triggered by a dotcom crash or financial crisis. Even so, the Brexit vote did cause unsettled economic weather which boosted some sectors and battered others.

Specifically, there was an acceleration in the performance of some shares that tend to move in sync with the economy – like cyclicals, sensitives and basic materials. On the flip-side, high yielding defensives lost ground.

With Brexit negotiations set to kick off after March 29, the economic uncertainty continues – but trends suggest that some sectors remain more attractive than others in these conditions. A simple way to see this is through the lens of the StockRanks.

Using StockRanks to find sector trends

StockRanks are a framework for assessing shares against three factors that have historically driven investment outperformance – Quality, Value and Momentum (QVM). Evidence shows that shares in good quality companies that are cheaply priced and have improving price and earnings strength, have a higher probability of performing well.

Over the past four years, a regularly refreshed basket of stocks in the top 10% of the market based on their combined QVM have strongly outperformed. Right now, a look at the top 10% basket (with a minimum market cap of £10m) suggests that cyclical and sensitive sectors offer a strong source of exposure to these factors. You can see this on the High StockRanks and Sectors screen here.

Metals – miners are digging in

2016 was a vastly better year for mining stocks after a prolonged spell out of favour. It was especially promising for those exposed to copper, gold and silver (metals which all rose in price). Anglo American was one of the best performers in the sector. With a StockRank of 99 it’s also one of the highest ranked stocks across the UK market.

Anglo American was an textbook case of how a sector upturn can trigger major ranking revisions. In March 2016 it had a weak StockRank of just 35, but a change was around the corner.

Improving price strength spurred by consistent earnings forecast upgrades catapulted Anglo American through the ranks. It hit 80 by June despite looking expensive because of its prior year losses. But this February it confirmed the bullish views of analysts with a swing back to profitability. As a result, it grew into its rising valuation, which pushed its StockRank into the top 10% band.

Anglo American now scores well across the ranks. To varying degrees a similar StockRank story played out at gold producers Centamin and Highland Gold Mining, as well as Rio Tinto and the copper producer, Central Asia Metals.

Housebuilders – the ultimate cyclical stocks

Shares in the UK’s major housebuilders fell off a cliff during the financial crisis and stayed in bargain territory for some time. It was an extreme example of how sensitive these companies are to the domestic economy. In the years since, their shares have soared but the Brexit vote last June shook them very hard indeed.

Once again, low interest rates and government assistance for new home buyers is helping to drive a recovery in these shares. They’re also scoring persistently high StockRanks. Firms like Bellway, Redrow, Persimmon, Taylor Wimpey and Galliford Try are ranking 99s and 98s. Barratt Developments and Crest Nicholson are right behind them.

Back in late 2015, the Value Rank component of the StockRank suggested the valuations of some housebuilders were becoming stretched. But that seems to have been corrected away and we’re now back to a period of strong momentum. Some investors are very wary of the housebuilding sector and its highly cyclical nature. But they’re currently in a StockRanks sweet spot.

Engineering – up on infrastructure spending

Housebuilders aren’t the only construction businesses with high combined exposure to Quality, Value and Momentum. A review of the list currently shows a trend for more infrastructure-related firms in engineering and construction to be faring well, too.

Both Costain and Morgan Sindall set the pace with StockRanks of 99. In the case of Costain, which has been ranking well for over a year, the company appears well positioned to benefit from increased spending on water, energy and transport infrastructure in the UK. Equally, Morgan Sindall looks well placed to capitalise on demand for urban regeneration and affordable housing projects.

They’re not alone, either. Severfield, a structural steel engineering group, reported its highest order book for six years last November. Strong half year results and higher earnings forecasts have propelled its momentum since then, driving the overall StockRank up to 92 (up from just 39 a year ago).

Elsewhere, John Laing has seen its StockRank rise from 59 to 92 over the past year. With a market cap of £1bn, this is much larger than the others and it has much broader geographical exposure. It specialises in public-private partnership infrastructure projects where it initiates projects and then either holds and manages them or sells them on. The company has welcomed the increasing use of more fiscal (rather than monetary) policies by governments in its markets, whereby infrastructure spending is being ramped up to stimulate economic growth.

Recruiters – an economic barometer

Back in the spring of 2014 we noted how recruitment firms had led the charge in what was turning out to be a bull run for small-caps. Many of them had high StockRanks and they were benefitting from from a pickup in the economy. Last year was much tougher for them, and the Brexit vote knocked prices across the board. But again, this has changed and some are clawing their way back.

Recent figures from the Office for National Statistics show that unemployment rates have dropped to a low not seen since 1975. That implies that domestic-focused recruitment firms ought to be doing well. It’s also the case that many of them have international businesses that may benefit from the tailwind of a weaker pound.

Robert Walters is the highest ranking recruiter with a StockRank of 99 (up from 78 a year ago). It recently reported record performance numbers, although nearly 70% of its net fee income (NFI) comes from abroad. To put that in context, its NFI grew by 19% to £278.3m last year. But on a constant currency basis the growth was a reasonable but much lower 8% – so it has done well from the devaluation of sterling.

Many in the sector seem to have been lifted in the current conditions. Other recruiters with StockRanks over 90 include Prime People, Staffline, SThree, Harvey Nash, Hays and Pagegroup.

Brighter skies in an uncertain market

There have been some dark clouds over the economy over the past year, and Warren Buffett’s enthusiasm for these moments probably isn’t shares by most investors. Cyclical and sensitive industry groups can be hit hard in these conditions. And if you look at a lot of consumer-facing cyclicals (like retailers, bars and restaurant groups), they remain under pressure.

Yet for a few cyclical industries, there have been rapid improvements in the performance and outlook for stocks. Major StockRank revisions have led to some industries having relatively large numbers of stocks with high exposure to Quality, Value and Momentum. Those with a tailwind of improving market conditions, domestic growth, government support and international exposure appear to be the main beneficiaries right now.

If you want to explore these ideas, there’s a top StockRanks screen here. Don’t forget you can use the StockRanks portal to find the highest ranking shares of any size or sector here, and find the biggest ranking movers here.

Stockopedia



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