Q1 2011 Quarterly Review Part 2: Australian Market Performance by Market Capitalisation
The first quarter of 2011 provided some major challenges for investors and the market. Floods and cyclones across eastern Australia, geopolitical unrest in the Middle East and North Africa, sovereign debt concerns in Europe and of course the Japanese earthquake, tsunami and nuclear crisis have produced major volatility throughout the quarter and changed investor confidence.
In Part One of our Q1_2011 Quarterly Review we examined the market on a sector-by-sector basis and gave our forecast of themes for the investment landscape for Q2 2011.
Today we’re reviewing the ASX market’s first quarter performance as measured by market capitalisation. This performance is illustrated in the chart below.
Chart: ASX Market performance by Market Cap for the Quarter Ending 31 March 2011.
Why Consider Market Capitalisation?
There are a number of reasons why investors and traders will look at market cap as a criterior when selecting stocks. Depending on the size of the investment portfolio liquidity may be an issue, and options traders will likely only consider the ASX 20 for liquidity reasons. Large cap, mid cap and small cap market segments will perform differently at various times in the market investment cycle.
Large caps tend to outperform when investors are more cautious or bearish, while small and mid caps are more likely to outperform when the bulls are in control, as this is when traders are more likely to accept the inherent risk.
For the purpose of analysis we have defined large caps as: ASX20 (.AXTL), ASX50 (.AXFL), ASX100 (.AXTO), ASX200 (.AXJO) and ASX300 (.AXKO). Mid caps: ASXMidCap50 (.AXMD), ASXMidCap_Industrials (.AXMD), and ASXMidCap_Resources (.AXMR). Small Caps: ASXSmall_Industrials (.AXSI), ASXSmall_ORDS (.AXSO), and ASXSmall_Resources (.AXSR).
Note: codes in brackets are for use in the Market Analyser software. Use these codes to review indices, and drill down to examine the stocks within. If you are not a Market Analyser user, sign up now for a free software trial.
Rolling Year-on-Year (YoY) Performance
The rolling year (YRRolling) performance (as shown by the black bars) illustrates just how difficult this market has been for long term investors, who tend to concentrate on large cap stocks. Annual performance has been generally negative, with the clear exception of mid and small cap resource stocks both segments rose over 26% for the YoY. The stocks making up the Small Ordinaries index also outperformed, up 10.6% YoY, while the Small Industrials and MidCap Top 50 eked out gains of around 2% YoY.
The other indices examined had negative performances of around -2% YoY, with MidCap Industrials the worst performers, down over -5%.
So investors or traders who ignored the mid and small cap resources (and the Small Ords) segments of the market will have underperformed for the year.
We saw the market volatility spike in March due to the Japanese disaster, but the market has undergone a stellar recovery from the lows of the severe sell-off. March performance (Mth (MAR)) (as shown by the green bars) has been flat across the board, which is surprising given the huge sell-off triggered by the Japanese disaster. However the small caps and mid caps underperformed and finished in the negative, indicating that investors are becoming more risk-averse due to the market volatility. For the month of March the S&P/ASX 20 and the Small Caps Industrial managed to finish over 0.5% higher for the month.
The quarterly (QTR_11Q1) performance (as shown by the blue bars) has revealed strength in the market leaders (measured by market cap). We highlighted in our report last quarter that investors would likely be taking profits on their small and mid cap resource stocks, moving their funds to the larger cap, more liquid stocks. The market volatility has been a catalyst for this rotation of funds. The top ASX 20 to ASX 300 stocks rose around 2% for the quarter. This performance was similar to that of the previous quarter, but performance of other market segments has turned around significantly.
The quarterly performance of the mid caps was relatively flat, however this is a significant turnaround for the mid cap resource stocks which were down -0.7%, down from 28% in the December quarter.
The small caps have also experienced a turnaround with small cap industrials managing to stay in the positive, up 0.9%, while the Small Ords and small cap resources finished down -1.9 and -5.3%, down sharply from 10.7 and 19% in the December quarter.
So investors or traders who failed to take profits in the small or mid cap resource segments of the market will have been hurting this quarter.
Weekly Rolling Performance for April 2011
We have analysed what has happened in the market for April so far. The weekly rolling (WkRolling) performance (as shown by the red bars) illustrates that the new quarter has begun with some selling/profit-taking, with under performing sectors last quarter leading to the recent sell-off lower. Only the ASX 20 and ASX 50 stocks have managed to eke out gains in early April, up 0.8% and 0.4% respectively.
The ASX MidCap 50, MidCap Industrials, and ASX SmallCap Ordinaries have all pulled back are least 1%, while SmallCap Resources have pulled back nearly -2%. The market closed at its lowest level in nine trading sessions overnight which points to weakness in the near term.
Again investors who trade larger cap stocks could have simply concentrated on the S&P/ASX 20 and still have generated a similar performance to those who used the S&P/ASX 300 as their stock investing universe. This is something that longer term investors should note, as it is much easier to keep track of 20 stocks versus 300 stocks, and investors can boost performances through the use of options on the top 20 stocks.
There has been a big turnaround in the stellar performances of the small cap and mid cap resource stocks, which is pointing to investor risk aversion. The market has experienced fantastic gains since the turnaround from the GFC in March 2009, but now markets globally are trading near key resistance levels and investors are becoming more cautious. Investors need to take advantage of the cheap insurance being offered through the options market to protect long-term positions. There is still M&A activity in the market as evidenced by the recent takeover bid for Equinox, so nimble traders can still profit.
The market remains a stock picker’s market as shown in the market performances over the past quarter. Those subscribers who follow the recommendations of MDS Financial Research get timely recommendations of trading opportunities as individual stocks start to move.
In summary the ASX20 and ASX50 stocks have outperformed. M&A activity will be a key driver going forward, particularly if we continue to see a pull-back in the resources sector, after Goldman Sachs recently made a call to take profits on commodities, given their spectacular performance. Aussie interest rates are likely to remain on hold for the near-term and the Aussie dollar being at record levels will impact corporate earnings.
Given the market performances over the past quarter and year-on-year, there are a number of strategies traders and investors can use, including relative strength comparisons and mean reversion.
1) Investors who use relative strength comparisons and look to trade strong stocks in strong sectors should concentrate on the larger cap stocks from the S&P/ASX 20 through to the S&P/ASX 300 universe of stocks. Using relative strength we would expect Small Ordinaries and SmallCap Resource stocks to continue to under-perform.
2) Investors who use a mean reversion strategy may want to concentrate on the SmallCap Resource and the MidCap Resource stocks, which have been underperforming the broader market, and if they are looking for the market to pull back, then they may look to the larger cap stocks to retrace.
Investors should gain confidence from the larger cap stocks holding on to their performances, but they may be tested with the indices trading around the 5000 level in 2011.
The investment themes for the next quarter will be:
* the economic recovery from the domestic floods and droughts
* the global economic recovery from the Japanese disaster
* geopolitical unrest in the Middle East and North Africa
* commodity supply constraints and pricing
* the strong Aussie dollar
* corporate earnings – can companies pass on higher input costs?
* interest rates and inflation
* continuing M&A activity
Stay tuned for further analysis of performances, as next time we will examine the performance of commodities in relation to stocks.
By Michael Hevern
Head of Research