More opportunities in small caps than blue chips: Morningstar
Make us a preferred source
Make us a preferred source on Google
The news: A market rally in the September quarter has left blue chip companies overvalued, with more opportunities in smaller stocks, according to Morningstar's Australian Equity Market Outlook report.
The numbers: Morningstar's report said the divergence between large and small caps was "stark", as the 20 largest stocks on the ASX — accounting for almost 60% of the benchmark S&P/ASX 200 index — traded at a premium of nearly 12%.
Financials traded about 8% above fair value during the last quarter which consisted of major banks that traded at an average premium of 17% with Commonwealth Bank the most expensive at 40%.
For small caps, almost 40% of Morningstar's coverage trades in "4- or 5-star territory", and most fall outside of the S&P/ASX 100.
The context: Morningstar said sectors have diverged "substantially" in 2024, with those likely to benefit from lower interest rates such as consumer cyclicals, financials, real estate, and technology outperforming.
The research house noted that energy was the most undervalued sector — 25% below fair value — as sluggish economic growth weighed on energy demand and prices. However, it saw attractive long-term value on offer in the sector.
There were also many undervalued stocks in the consumer, healthcare, technology and communications services sectors, Morningstar said.
Morningstar said its top picks in each sector were:
- Nufarm, Iluka Resources and IGO in basic materials;
- Nine Entertainment, Spark New Zealand and TPG Telecom in communication services;
- Kogan.com, Domino's Pizza and Bapcor in consumer cyclical;
- IDP Education, Endeavour Group and A2 Milk in consumer defensive;
- Woodside Energy, Santos and Whitehaven Coal in energy;
- Insignia Financial, ASX and NIB in financials;
- Ramsay Health Care, ResMed and Ansell in healthcare;
- Aurizon, Brambles and Amcor in industrials;
- Dexus, GPT Group and Charter Hall Group in real estate;
- Fineos, SiteMinder and Pexa Group in technology; and
- Manawa Energy, APA Group and AGL Energy in utilities.
Elsewhere, Morningstar said the sharemarket is "at odds" with the Reserve Bank over rate cuts, with restrictive monetary settings impeding economic growth.
It flagged that that the market is not convinced that the RBA board doesn't foresee a cut before Christmas. Cash rate futures price a 25% chance of a cut at the RBA's November meeting and almost a 90% chance in December, it said, likely steered by monetary easing from other central banks.
Morningstar noted that smaller caps outside the S&P/ASX 100 "can do well" if the RBA can "take some of the economic risk off the table by "sticking a soft landing".
The source: Morningstar market outlook
