There is a growing disconnect between valuations and fundamentals, which is contributing to “crazy” multiples and a growing propensity towards momentum-driven investing, according to Schroders’ head of Australian equities, Martin Conlon.
Conlon noted that the intense focus on technology was especially surprising during the recent reporting season. In particular, he highlighted the “ludicrous” scale of investor reactions to what were, in most cases, “very small” earnings surprises, as demonstrated by WiseTech Global in the Australian market.
In a recent webinar, Conlon explained that while WiseTech Global’s revenue increased by $250 million and earnings rose from $300 million to $380 million – largely due to acquisitions – along with $60 million more in capitalised R&D, the market cap surged by over $9 billion, which he emphasised is “larger than most companies in Australia, let alone as a price move”.
Notably, the stock surged 17 per cent on the day of its earnings report, driven by soaring profits and the growth outlook, and as at 9 September, it is up more than 60 per cent year to date.
Such optimism demonstrates how the technology sector’s rapid rise has led to “pretty crazy” price-to-earnings multiples, Conlon explained.
“I think we all know [tech is] at the epicentre of speculative activity around the world, the Nvidias of the world in the US. That’s where prices can move most and people are attracted to prices that move most because they love a fast buck,” he said.
Conlon noted that while the ASX is relatively expensive compared to other markets globally, the widespread enthusiasm for growth, especially in markets like the US and India, is driving up valuations as investors flock to growth opportunities.
“People are running to where the growth is. Markets like India, [they’re] very expensive because it’s growing,” Conlon said.
“Mention growth and investors get excited.”
However, as fundamentals seemingly take a back seat in favour of growth, the investment executive flagged the need for caution.
“It worries me how many fundamental investors look at those reactions and then assimilate that behaviour such that they almost lose sight of fundamentals and become momentum investors themselves,” he said.
“I think that’s one of the more dangerous trends in equity markets.”
Areas of promise
Conlon observed that while markets are generally expensive, most of the elevated valuations are concentrated in a few sectors such as IT, leaving room for opportunities in less inflated areas.
“I think it’s very difficult to argue that anywhere looks cheap relative to interest rates, so market prices and asset values across property and equity markets remain pretty expensive versus history. But if you dig below the surface, most of the market being expensive is really driven by a couple of very highly priced sectors. IT remains the main one,” he said.
For investors happy to expand beyond this narrow rally, Conlon recommended areas like resources, materials, and energy, which are trading at “very normal multiples”.
Also appearing on the webinar, Justin Halliwell, head of research at Schroders, said results in the mining space have been noteworthy.
“One thing that struck me in the results in the mining space is that earnings have remained stable, both at price level and at cost level, which is unusual particularly in the big end of town,” Halliwell said.
Additionally, while steel companies face shrinking margins as Chinese steel exports near a record 100 million tonnes, he believes most investors are missing the long-term opportunity.
“While logic suggests supply will reduce and margins will rebound, the time frame for logic to prevail is often longer than expected,” Halliwell said.
“Companies with a healthy balance sheet and strong cost position will be well placed to enjoy the inevitable improvement.”
