LOGIN JOIN SHARECAFE SIGN UP FOR OUR NEWSLETTER ADVERTISE
share cafe logo  
 
SHARECAFE COMMENTARY

Looking For The Underlying Market Structure
BY TIM KELLEY - 02/02/2018 | VIEW MORE ARTICLES BY THE MONTGOMERY TEAM

We recently undertook an analysis to try to better understand the structure and behaviour of the equity market, with a view to identifying cause and effect relationships that drive investment performance.  While the work is ongoing, some interesting early findings are emerging.

The way we approached the task was firstly to organise the equity market into industry clusters based on similarity of investment performance.  This is similar in concept to GICS industry groupings (and in many cases, aligns well with GICS classifications), but instead of assigning stocks based on someone’s judgement of how a stock should behave, we classified them based on how they did behave.  This threw up some interesting differences, some of which appear quite logical and reasonable (for example Seek, Carsales and REA Group all ending up in the same cluster), and some of which are not so intuitive.  In addition, there were quite a few stocks that did not readily fit into any cluster.  For our purposes it makes sense to exclude those ones

If you’re interested, a list of ASX clusters based on 5 years of data is set out at the end of the post.

Having identified these clusters, we can then consider how different external effects flow through into the investment performance of each.  One topical example might be to ask how different clusters perform in an environment of rising short-term interest rates.

Unfortunately, there are some big challenges to properly doing this analysis.  In particular, we need to look at several decades of historical data, and in the Australian equity market there aren’t a great many companies that have been listed and doing the same thing for that length of time.  This is a problem we should be able to solve with further work, but for now we have supplemented the Australian analysis with an analysis of the US market, which provides a much more comprehensive data set.

Some of the early (and still preliminary) findings include the following:

You might expect that rising interest rates are bad for clusters with defensive/bond like characteristics, like utilities and staples, and you’d probably be right.  Unfortunately, the market seems to get out of bed early on this one, and the performance impacts for those stocks are typically seen before the interest rate changes take effect. This is perhaps not surprising, as the market generally knows in advance which way interest rates are heading, and it is a simple mechanical exercise to adjust a valuation discount rate to adjust for this.

What is a little more surprising is that there does seem to be a lagged effect of interest rate changes for banks and for discretionary retailers:  For example, where interest rates have risen in the past 12 months, the forward returns for those clusters appear to be depressed. While it may be obvious that rising interest rates should negatively impact demand for credit and for retail goods, it seems that the market may take some time to factor this in.  This might be explained by the fact that it is not straightforward to forecast the ultimate impact on demand, particularly if interest rate rises occur in the context of strong economic growth.

This may be something to keep in mind if we see the RBA becoming increasingly worried about rising inflation.

Another surprising finding is that rising oil prices appear to predict future outperformance for energy companies.  We would expect the market to pick up pretty quickly on this one, such that by the time you have noticed the rising oil price its too late to take advantage of it by buying energy companies, but the evidence suggests otherwise.

It’s possible that this is because producing a revised commodity price “deck” is a big exercise for investment bank economists, and so it takes some time for changes to flow through into updated price decks and then into the forecasts and valuations of the sector analysts.  Nonetheless, this lag effect is a little surprising.

It’s also potentially interesting, given that oil prices have been on the rise in recent months. Energy companies generally don’t fit our quality-driven investment style, but for those with more of a trading orientation, this may be something to keep in mind.

We continue to sift through the data in search of gems of insight, but there seems to be one overarching conclusion emerging: if something is obvious to others in the equity market then it likely has no investment value – it should already be factored into prices.  However, investment markets are not omnipotent; if something is difficult or time-consuming to assess, it is probably worth making the effort to understand it better than others.

Name Sector Industry
BHP BILLITON LIMITED Materials Metals & Mining
RIO TINTO LTD Materials Metals & Mining
FORTESCUE METALS GROUP LTD Materials Metals & Mining
ORICA LTD Materials Chemicals
BLUESCOPE STEEL LTD Materials Metals & Mining
ALUMINA LTD Materials Metals & Mining
MINERAL RESOURCES LTD Materials Metals & Mining
SIMS METAL MANAGEMENT LTD Materials Metals & Mining
     
COMMONWEALTH BANK OF AUSTRAL Financials Banks
WESTPAC BANKING CORP Financials Banks
AUST AND NZ BANKING GROUP Financials Banks
NATIONAL AUSTRALIA BANK LTD Financials Banks
     
WESFARMERS LTD Consumer Staples Food & Staples Retailing
WOOLWORTHS GROUP LTD Consumer Staples Food & Staples Retailing
TREASURY WINE ESTATES LTD Consumer Staples Beverages
COCA-COLA AMATIL LTD Consumer Staples Beverages
INVOCARE LTD Consumer Discretionary Diversified Consumer Services
     
SUNCORP GROUP LTD Financials Insurance
INSURANCE AUSTRALIA GROUP Financials Insurance
AMP LTD Financials Diversified Financial Services
NIB HOLDINGS LTD Financials Insurance
     
CSL LTD Health Care Biotechnology
AMCOR LIMITED Materials Containers & Packaging
BRAMBLES LTD Industrials Commercial Services & Supplies
RAMSAY HEALTH CARE LTD Health Care Health Care Providers & Servic
ASX LTD Financials Capital Markets
COCHLEAR LTD Health Care Health Care Equipment & Suppli
ANSELL LTD Health Care Health Care Equipment & Suppli
CORPORATE TRAVEL MANAGEMENT Consumer Discretionary Hotels, Restaurants & Leisure
NAVITAS LTD Consumer Discretionary Diversified Consumer Services
ARB CORP LTD Consumer Discretionary Auto Components
SIRTEX MEDICAL LTD Health Care Biotechnology
     
WOODSIDE PETROLEUM LTD Energy Oil, Gas & Consumable Fuels
ORIGIN ENERGY LTD Energy Oil, Gas & Consumable Fuels
OIL SEARCH LTD Energy Oil, Gas & Consumable Fuels
SANTOS LTD Energy Oil, Gas & Consumable Fuels
WORLEYPARSONS LTD Energy Energy Equipment & Services
WHITEHAVEN COAL LTD Energy Oil, Gas & Consumable Fuels
BEACH ENERGY LTD Energy Oil, Gas & Consumable Fuels
     
CIMIC GROUP LTD Industrials Construction & Engineering
SEVEN GROUP HOLDINGS LTD Industrials Trading Companies & Distributo
DOWNER EDI LTD Industrials Commercial Services & Supplies
ALS LTD Industrials Professional Services
MONADELPHOUS GROUP LTD Industrials Construction & Engineering
     
JAMES HARDIE INDUSTRIES-CDI Materials Construction Materials
BORAL LTD Materials Construction Materials
FLETCHER BUILDING LTD Materials Construction Materials
ADELAIDE BRIGHTON LTD Materials Construction Materials
CSR LTD Materials Construction Materials
     
MACQUARIE GROUP LTD Financials Capital Markets
QBE INSURANCE GROUP LTD Financials Insurance
JANUS HENDERSON GROUP-CDI Financials Capital Markets
COMPUTERSHARE LTD Information Technology IT Services
BT INVESTMENT MANAGEMENT LTD Financials Capital Markets
PERPETUAL LTD Financials Capital Markets
     
REA GROUP LTD Information Technology Internet Software & Services
SEEK LTD Industrials Professional Services
DOMINO’S PIZZA ENTERPRISES L Consumer Discretionary Hotels, Restaurants & Leisure
CARSALES.COM LTD Information Technology Internet Software & Services
     
NEWCREST MINING LTD Materials Metals & Mining
EVOLUTION MINING LTD Materials Metals & Mining
NORTHERN STAR RESOURCES LTD Materials Metals & Mining
REGIS RESOURCES LTD Materials Metals & Mining
ST BARBARA LTD Materials Metals & Mining
SARACEN MINERAL HOLDINGS LTD Materials Metals & Mining
RESOLUTE MINING LTD Materials Metals & Mining
     
HARVEY NORMAN HOLDINGS LTD Consumer Discretionary Multiline Retail
JB HI-FI LTD Consumer Discretionary Specialty Retail
SUPER RETAIL GROUP LTD Consumer Discretionary Specialty Retail
MYER HOLDINGS LTD Consumer Discretionary Multiline Retail
     
TELSTRA CORP LTD Telecommunication Services Diversified Telecommunication
RESMED INC-CDI Health Care Health Care Equipment & Suppli
ARISTOCRAT LEISURE LTD Consumer Discretionary Hotels, Restaurants & Leisure
FISHER & PAYKEL HEALTHCARE C Health Care Health Care Equipment & Suppli
SPARK NEW ZEALAND LTD Telecommunication Services Diversified Telecommunication
TPG TELECOM LTD Telecommunication Services Diversified Telecommunication
DULUXGROUP LTD Materials Chemicals
SKYCITY ENTERTAINMENT GROUP Consumer Discretionary Hotels, Restaurants & Leisure
TRADE ME GROUP LTD Consumer Discretionary Internet & Direct Marketing Re
CHORUS LTD Telecommunication Services Diversified Telecommunication
AUSTRALIAN PHARMA INDUS LTD Health Care Health Care Providers & Servic
     
BLACKMORES LTD Consumer Staples Personal Products
TECHNOLOGY ONE LTD Information Technology Software
ALTIUM LTD Information Technology Software
NEXTDC LTD Information Technology Internet Software & Services
     
ILUKA RESOURCES LTD Materials Metals & Mining
OZ MINERALS LTD Materials Metals & Mining
INDEPENDENCE GROUP NL Materials Metals & Mining
OROCOBRE LTD Materials Metals & Mining
SYRAH RESOURCES LTD Materials Metals & Mining
SANDFIRE RESOURCES NL Materials Metals & Mining
WESTERN AREAS LTD Materials Metals & Mining

The Montgomery Funds own shares in Seek and REA 

The Montgomery Global Funds own shares in REA



View More Articles By The Montgomery Team

Roger Montgomery is the Chief Investment Officer of Montgomery Investment Management, montinvest.com, and author of blog.rogermontgomery.com.

Roger's step-by-step guide to valuing the best stocks and buying them for less than they're worth, Value.able, is available exclusively at rogermontgomery.com. Skaffold is an online stock-picking application that rates ASX-listed stocks from A1 to C5. Watch a demo of Skaffold at www.skaffold.com.



 

RECENTLY ADDED TO SHARECAFE


 › Marcus Today End Of Day Report
 › Friday At The Close
 › Beats and Misses
 › Bitcoin No Replacement For Gold
 › Is The Bear Out Of Hibernation?
 › Warren Buffett's Latest Portfolio Reshuffle
 › Australian's Love Affair With Debt - How Big Is The Risk?
 › Market At Midday On Friday
 › Not One, Not Two, But Three For Dacian As First Gold Production Looms
 › Next Week At A Glance
 › Overnight: The Big 'V'
 › Amazon Disruption Continues
 › What Lies Ahead For The Big Bank Stocks?
 › Is Solomon Lew Gaslighting The Aussie Market?
More ShareCafe   

GET THE SHARECAFE BREAKFAST BRIEFING


Delivered free to your inbox before the market opens each trading day. Sign up below +

SHARECAFE VIDEO


View More Videos