Investors are likely to increase their focus on value stocks in this financial year as our bull market starts to run out of puff and valuations of the best performing stocks become stretched.
This means picking the best stocks in the worst sectors could be a winning investment strategy for FY19!
It’s a fairly predictable trend in any market cycle. Stocks with the best growth prospects surge ahead and trade at a premium to the S&P/ASX 200 (Index:^AXJO) (ASX:XJO), while those that don’t lag far behind.
That is until the last stages of a bull market when investors start to question the high multiples they have to pay for growth stocks, which in turn forces them to hunt for bargains among the laggards in the sectors with the dimmest outlook.
But sector rotation is a cyclical affair. What is down last year often rebounds in the next year or three. On that note, some of the most disliked large cap stocks in FY18 could find love in this new financial year.
To be clear, not all laggards will come bouncing back into favour. If anything, I think most will continue to struggle although there will be a handful of diamonds in the rough.
To help navigate the minefield, I’ve decided to look at Morgan’s best stock picks for the various sectors on our market, starting with the beaten-down banking sector that’s struggling against the slowing housing market and the Royal Commission.
The big banks have been among the worst performing blue-chip stocks for FY18 but Morgans thinks there’s value in the sector and has picked Westpac Banking Corp (ASX: WBC) as the best bank stock to back.
The broker’s preference for Westpac over the other banks stems from Westpac’s defensively positioned loan book, relatively low reliance on treasury & market income, and its strong management team.
Morgans also believes that the risks to the banks have been overstated given that owner-occupier loan growth has hit 8% over the last 12 months and the slowdown in investor loan growth has bottomed.
Telcos have been another sore spot for investors in FY18 and Telstra Corporation Ltd (ASX: TLS) has been the worst performing blue-chip stock over the period. But Morgans thinks Telstra is at a turning point.
“In June, Telstra’s management outlined what is, without a doubt, the largest ever turnaround initiative for the company. Telstra is now targeting a $2.5bn cost out program (previously $1.5bn),” said Morgans.
“Interestingly as part of Telstra’s restructure they will change reporting segments and include a new “Infrastructure Co” business unit. We think this is significant as it sets the stage for a future where TLS can either divest its infrastructure assets or more likely, in our view, the NBN can be vended into Infrastructure Co.”
Infrastructure and utility stocks have also been underperforming as the spike in bond yields has diminished the attractiveness of investing in the sector, while regulatory pressure on power infrastructure, toll roads, and airports has further dampened the outlook for these defensive stocks.
The only bright spot is the takeover attempt of gas pipeline business APA Group (ASX: APA), but it’s foolish to try to pick stocks just on takeover appeal.
I suspect the outlook for the sector will remain challenging through FY19 and even Morgans says its difficult to find compelling value among the large cap stocks in this space.
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Motley Fool contributor Brendon Lau owns shares of Telstra Limited and Westpac Banking. The Motley Fool Australia owns shares of and has recommended Telstra Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.