Courtesy of the AFR today. Some "learned observations" from our friends at UBS - we will see how his predictions fare over the next few months no doubt....
It's time to be wary if you own shares in high-flying market darlings as one of Australia's top strategists warns red-hot price gains may be running ahead of earnings expectations.
UBS chief strategist David Cassidy warned a group of growth stocks that includes CSL, which strode to a record high on Wednesday, look richly priced relative to their earnings outlook, exposing investors to the risk of a decline in stock prices if earnings disappointed investors' high expectations.
"We're treading a bit cautiously in that part of the market," David Cassidy told TheAustralian Financial Review. "There were a few wobbles [recently] in that portion of the index and we saw the issues with A2 Milk and Treasury Wine. I am concerned how much the market is paying for those market darling stocks at the moment."
A2 Milk underscores the risks that come from being a market darling. The dairy producer's shares shed a quarter of their value in one day after an update earlier this month, even though revenue increased 70 per cent from the same time last year.
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David Cassidy says that the 'market darling' stocks are overvalued. Lee Besford
Mr Cassidy said 10 growth stocks that have dominated the performance of the growth sector, and they account for more than 10 per cent of the S&P/ASX200 Index. This group of stocks is trading at almost twice the valuation - based on price earnings multiples - of the Australian sharemarket excluding resource stocks.
These stocks include Treasury Wine Estates, REA Group, Cochlear, Aristocrat and ResMed. Also included are James Hardie, A2 Milk, Seek and Carsales. He still like Aristocrat and Treasury, but warned Cochlear and REA Group "appear at risk".
"Normally, this doesn't end well. Normally those valuations correct," Mr Cassidy said. "Is the market now paying too much for those stocks? Its an interesting question. I'm not exactly sure what will be the catalyst to see them pull back but we are underweight that part of the market."
"It may just be a case that stock-by-stock they just run into problems and that the expectations just get too big," said Mr Cassidy. "We saw [that] with A2 and arguably Treasury, they just start to disappoint what are very lofty expectations. Its not a portfolio outflow en masse. They just start to struggle against their own expectations over a couple of years." Poor sector mix
He did admit he thought this correction would have already happened, adding that there was a possibility that these stocks simply kept on growing.
"I thought the bond yield might have pressured valuations but it really hasn't so far, possibly because the Australian bond yield hasn't sold off as much," he said. "I still think, possibly if the US bond yield moves materially higher from here, there still could be an issue there in terms of high P/E stocks ultimately getting pressured by the discount rate moving up. But I could be wrong and they could just keep ploughing ahead."
Mr Cassidy said Australia's poor sector mix was helping to push the share prices of these names higher as Australian investors looked for more exposure to the global growth markets.
"It's partly a function of not having an IT sector of any size," he said. "The market is trying to find some structural growth, possibly because it doesn't perceive a lot of growth in the domestic economy and those big secure domestic sectors like banking.
"We're inherently short IT and long banking which is not a good sector mix when you look at what's been performing domestically and globally.
Mr Cassidy said that while healthcare stocks were well liked by investors, there was much better value to be found elsewhere on the ASX.
"The big global healthcare champions CSL, Cochlear, ResMed are looking very expensive in a long term context against the more domestically focused sectors," he said.
He said that mining and energy companies were a cheaper investment and were sitting at an "attractive mid-cycle valuation."
"I'm more inclined to like resources and what I call a bunch of GARP [growth at a reasonable price] stocks that are not as cheap as perhaps the banks, telcos and discretionary retail, but they have growth," he said.
A2M Price at posting:
$10.22 Sentiment: Hold Disclosure: Held
(20min delay)