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The ‘4 C’s’ creating opportunities for patient investors

By ST Wong
4 minute read

Ongoing divergence between the performance of key stocks and sectors is creating opportunities for investors who are patient enough to look beyond short-term fears and see that good Australian companies are making bold changes which should pay off in the mid to longer term.

The latest reporting season showed increasingly divergent outcomes for stocks and within sectors, a trend which is potentially long-lasting. This was demonstrated by the major contrast in how the market reacted to similar stocks.

For example, the major supermarkets saw Woolworths down 1 per cent in August but Coles heavily sold down by 10 per cent. We’re seeing similar with the major real estate portals, Domain down 4 per cent in August but REA up 4.7 per cent.

The major banks are also showing divergence, with Westpac down following reporting, while NAB rose. And we see it in the AREIT stocks, with Goodman Group enjoying strong results while GPT is down.

There are strong reasons to believe this divergence could be a lasting trend, mainly due to the “four C’s”, which are currently wielding significant influence on markets. The four C’s are: consumers, cost inflation, cost of debt, and capital expenditure.

The consumer is obviously experiencing pressure from persistent inflation and the rapid rise in interest rates. This has shown up in soft economic numbers and plummeting consumer confidence.

Cost inflation is impacting both consumers and companies, and as much as we would all like inflation to abate, it is proving sticky due to factors such as a persistently high oil price, which impacts household budgets and costs right through the supply chain.

The cost of debt continues to be a factor and it’s not just the potential impact on mortgage holders, which is significant, particularly for first home buyers and those who increased their borrowing commitments in recent years. It’s also a big influence on the performance of companies with higher debt levels. There seems to be more discussion about rates being “higher for longer” as forecasts for potential rate cuts continue to be pushed out into the future – hence debt could be a factor for some time to come.

The final of the four C’s is capital expenditure, which is going through the roof in many cases. This is partly due to the influence of cost inflation and the cost of debt. But it’s also fair to say many sectors are either restructuring or in a state of flux and needing to spend capital either to pivot for their next phase of growth, or to gain more control over their supply chains.

While these “four C’s” continue to hold sway, the market is gravitating to stocks which are giving investors the comfort of certainty. The market is craving certainty regarding earnings growth in particular.

This desire for certainty is fuelling short-termism, as markets are currently focused on whether the economy is slowing.

This short-termism creates opportunity for investors.

The market is ignoring often bold mid- to long-term initiatives being put in place by Australian leaders. These leaders are taking a broader view, with management already thinking about the next five years and beyond. A common theme among these leaders is exploring how they can leverage technological advances to deliver new products.

These companies are prepared to look through economic issues. For example, CSL is investing in capabilities to drive long-term margin expansion through data analytics and process improvements. Another is Goodman Group, and its pivot towards data centres, with a pipeline five times larger than the size of Australia’s current largest listed data centre.

The market’s short-term focus, driven by anxiety about the four C’s, and the desire for certainty, is creating volatility in share prices. The opportunity for investors is to look through the short-term noise to buy at attractive valuations.

The short-term focus also brings significant risk. Not all companies are able to “flex” or “pivot” into a new direction. If the short term becomes too important, we risk missing the good companies which will do well across the next two to three years.

There are always good opportunities for those prepared to look to the medium-to-longer-term and target companies which are financially healthy, have strong management and a product or service that’s in demand.

Currently, we’re seeing plenty of positives in sectors including diversified financial services, health insurance companies, and investment platform providers such as HUB24, which appear to be in a sweet spot.

ST Wong, chief investment officer, Prime Value Asset Management