As the economy falters, value stocks may prove the safer bet: Analyst

Less-than-stellar company results and downcast communications from the August reporting season belie investors’ apparent market exuberance, with seemingly few investors prepared for anything other than a ‘Goldilocks’ outcome for the global economy, says a leading market analyst.

For Reece Birtles, Martin Currie Australia’s chief investment officer, listed companies’ lacklustre earnings results echo the poor conditions experienced back in 2019. This should be cause for some investor jitters.

However, Birtles warns, it appears few investors are prepared for the reality of a low-interest, low-inflation environment – and, indeed, the reasons behind why the economy may be turning.

“The last 12 months’ returns for the key indices suggest the market is behaving as if a ‘Goldilocks’ economic landing is actually possible,” he said.

“Investors appear overly hopeful about the positive impacts of lower inflation and interest rates, ignoring the fact that lower inflation means a less desirable, slowing sales environment as consumers spend less.”

Current market prices, post-reporting season, appear to be “disregarding any evidence that contradicts the ‘Goldilocks’ narrative for the economy”. This has led to a surge in stock prices that belie companies’ actual – largely lacklustre – reported earnings growth, Martin Currie noted.

For Birtles, there appears a clear disconnect between the share market exuberance and the less sanguine feedback it has received from corporate management teams.

“In our company engagements and visits, we noted general feedback that consumer demand weakness has now joined business demand weakness as a key issue. In previous reporting seasons consumer demand had been resilient and enough to maintain margins,” Birtles said.

Based on Martin Currie analysis from end of August, more than 40% of companies have received downgrades to their earnings per share (EPS) forecasts, while just a quarter received upgrades.

“The biggest driver of the weak guidance from management was the slowing inflationary environment that everyone seems to be wishing for, which is making it a lot harder for companies to maintain or grow EPS,” the asset manager noted.

Safety in value stocks

Martin Currie Australia sees growth-style stocks as overpriced, with value stocks still “cheap” relative to historical standards. While value often correlates with higher risk, the current market has created an inverse scenario.

“In this market, focus should be on companies with pricing power, resilient volumes, and the capacity to manage margins, while avoiding those with valuation risk.”

“Normally it is said that risky stocks are the ones that are cheap, but at the moment, safety is actually not expensive.

“We are finding undervalued names that have defensive business characteristics or profit drivers less related to the broader economic cycle,” Birtles said.

 In the local market, Martin Currie rates Perth-based mining and metals extractor South32, “which has undertaken a significant business transformation focussed on copper and other materials needed for the energy transition”, Worley, an NSW-based engineering and consultancy company, which it says will “benefit from increased spend in renewables in future years”, and Flight Centre Travel Group, “which has made significant business efficiency improvements and is seeing ongoing demand growth”, as strong and safe value prospects.