There are growing fears that our market is facing another sell-off following its big relief rally since the start of the year. I think the easy gains are gone and it will be much harder to pick the winners that can outperform over the next six to 12 months.
The S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index is showing signs of stress this morning as it shed 0.4% of its value on poor offshore leads and the perception that a lot of good news has already been priced into this asset class following the 13% gains the top 200 benchmark has made since the trough in late December last year.
Morgans makes the point that the impressive “V” shape rally stands in contrast to consensus earnings downgrades in FY19, which currently stand at an anaemic 3%.
Market vulnerable to sell-off
“Expectations for FY19 corporate profits (ex-Resources) eroded a further and sees the market tracking toward a very tepid looking 4.1% compound annual growth in profits over the next 3 years,” said Morgans.
“This contrasted a sharp lift in valuations, with the ASX200 Industrials 12-month forward PE recovering to pre-selloff levels at ~16.1x.”
The broker pointed out the similarities between market pricing and fundamentals now compared to six months ago when the ASX suffered a big sell-off. Our market looks vulnerable.
Pockets of opportunities
However, there are new opportunities post the February reporting season, according to Morgans. These stocks look well placed to outperform even despite the headwinds from elections, falling house prices and other geo-political risks.
These new opportunities can be divided into five categories:
- Offshore Growth Stocks: These are stocks with significant offshore earnings exposure and have the potential to growing profits even if global economic growth slows modestly. These stocks include the likes of Treasury Wine Estates Ltd (ASX: TWE) and Corporate Travel Management Ltd (ASX: CTD).
- Steady Cash-flow Growers: These are stocks that Morgans is reasonably confident can keep growing their cash-flows. These stocks include Wesfarmers Ltd and Origin Energy Ltd (ASX: ORG).
- Tailwind Riders: Conditions may be growing more challenging for the market as a whole but there are niche sectors that have a brighter outlook. Stocks leveraged to these tailwinds include Oil Search Limited (ASX: OSH) and PWR Holdings Ltd (ASX: PWH).
- Recovery Candidates: Morgans notes that among the stocks on the ASX that have run into earnings difficulties in the past, some have past their cycle-lows. Examples include Telstra Corporation Ltd (ASX: TLS) and QBE Insurance Group Ltd (ASX: QBE).
- Forgotten Bargains: Finally, there are a group of stocks trading on low valuations that have fallen off the radar of many investors. Morgans thinks this group includes the likes of CML Group Ltd (ASX: CGR), Bingo Industries Ltd (ASX: BIN) and Noni B Limited (ASX: NBL).
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Motley Fool contributor Brendon Lau owns shares of QBE Insurance Group Ltd. and Telstra Limited. The Motley Fool Australia owns shares of and has recommended Corporate Travel Management Limited, Telstra Limited, Treasury Wine Estates Limited, and Wesfarmers 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.