Just as there are fundamental and technical styles to investing, there are also numerous kinds of stock and asset pickers. The two main styles in this context are the quantitative investors (people who use leverage and mathematics to exploit market mis-pricing) and qualitative investors (people who use models and moats to identify the best opportunities). And while both styles are perfectly reasonable, using either style can often lead to very different outcomes.
A perfect case in point is two sell-side notes which were recently published. One, written by the quant sell-side team at Morgan Stanley, use a proprietary model to identify the best and worst stocks to hold. The other, written by UBS' qualt sell-side team, use a range of bottom-up indicators to identify a best and worst ideas list respectively.
So which style produces which results?
In its recent weekly markets note, Morgan Stanley's quant team shared an update to its best and worst ideas list. Every update utilises a proprietary model called MOST, which filters the ASX 200 into a list of opportunities and pitfalls.
At any one time, the list has up to 12 "most preferred" ideas and up to 5 "least preferred" ideas. Note that "most preferred" and "least preferred" do not necessarily mean buy or sell - it could just be a high conviction hold!
There are also sector limits - no more than two stocks from the one sector appear on the list
This does not appear to be a macro-driven list, so the house view's call of one more rate hike from the RBA may not necessarily influence the final outcome of the list.
"To be considered for selection within the most preferred stock ideas, stocks are within the top two quintiles of our alpha model MOST and rated Overweight by our fundamental analysts and have upside to Morgan Stanley's price target. In the event that there are not enough stocks with a fundamental Overweight stock rating, within the top two quintiles, we then select the highest ranked stock(s) that are rated Equal-weight," analysts wrote.
"To be considered for selection within the least preferred stock ideas, stocks are within the bottom two quintiles of our alpha model MOST and rated Underweight/Equal-weight by our fundamental analysts with downside to Morgan Stanley's price target," analysts also explained.
Finally, before the quants sign off on the list, they seek the input of the Morgan Stanley fundamental stock analysts.
In the most recent update, Morgan Stanley made four changes to its "most preferred" list.
Existing constituents: The Lottery Corporation (ASX: TLC), Orica (ASX: ORI), South32 (ASX: S32) and Qantas (ASX: QAN) left the list.
TLC and S32 moved into the third quintile (that is, the middle portion of the model) while ORI and QAN moved into the fourth quintile. A fourth-quintile spot puts those companies dangerously close to making it into the "least preferred" list.
In its place, four new stocks were added to the "most preferred" list - including Deterra Royalties (ASX: DRR), REA Group (ASX: REA), Stockland (ASX: SGP), and ANZ (ASX: ANZ). The latter was called out by Morgan Stanley's banks analyst Richard Wiles as the top choice of the space.
CBA (ASX: CBA), Westpac (ASX: WBC) and Bank of Queensland (ASX: BOQ) were all placed into the "least preferred" category - which must say something about the disparity in opportunities in the ASX banking sector. And yes, there are more than two financials-linked stocks in this category, which contravenes their own rules.
UBS' sell-side equities team, led by strategist Richard Schellbach, are looking at this market from a qualitative standpoint. Top of mind for them, is how you can play the higher for longer mantra through stocks.
"Unlike through the middle of last year when bond yields spiked higher on genuine stagflation fears, the current move up in rates is driven by developments that are not quite as destructive to equities," Schellbach wrote.
UBS' economics team, led by George Tharenou, believe there won't be another rate hike this cycle but they also believe the RBA won't cut rates until at least the back half of 2024. And Schellbach also points out something else:
"The end of an RBA rate hiking cycle does not herald the return of equity market leadership from the domestically driven cyclical sectors," he wrote.
So which stocks would you want to buy in a "higher for longer" rate plateau scenario? Here are their picks - labelled as "potential positive" and "potential negative":
Banks: ANZ (ASX: ANZ) over NAB (ASX: NAB)
Wider financials: QBE (ASX: QBE) and Computershare (ASX: CPU) over listed fund managers
Tech: Wisetech (ASX: WTC) and Xero (ASX: XRO) over Dicker Data (ASX: DDR) and Domain (ASX: DHG)
REITs: Goodman Group (ASX: GMG) and Mirvac (ASX: MGR) over Charter Hall (ASX: CHC)
Industrials: Cleanaway, James Hardie (ASX: JHX) and Orica (ASX: ORI) are their preferred picks.
Consumer: Supermarkets (ASX: COL) and Woolworths (ASX: WOW) over Discretionary, Kelsian (ASX: KLS) over Qantas (ASX: QAN)
Resources: Coronado (ASX: CRN) over the gold producers (higher rates tend to hurt gold producers in the long run)
Agriculture: Inghams (ASX: ING), GrainCorp (ASX: GNC), and Ridley Corp (ASX: RIC)
This article was originally published for Livewire Markets on Tuesday, 10 October 2023.
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