|Summary: The make-up of the key indices in the Australian sharemarket is continuing to change as more mining stocks lose value. But stocks than enter an index tend to attract buying support, and this could be the case for bigger stocks that have slipped out of the bigger indices into smaller capitalisation indexes.|
|Key take-out: Small industrial stocks represented on the Small Ordinaries Index are at a record high, representing around 70% of the index.|
|Key beneficiaries: General investors. Category: Portfolio construction.|
The make-up of our market is changing right in front of our eyes, with scores of mining and mining services stocks tipped to be dumped from key equity indices in the coming months.
WilsonHTM Investment Group estimates that the Standard & Poor’s (S&P) Small Ordinaries Index will lose around 20% of its junior resource stocks by number next month as the small resources sector has crashed 34% over the past 12-months compared with a 14% rally by small industrial companies.
The impact will also be heavily felt in the larger cap indices, with the vast majority of demotions in the S&P/ASX 100, S&P/ASX 200 and S&P/ASX 300 indices coming from the resource-related sectors.
This fall from grace means that small industrial stocks represented on the Small Ordinaries are at a record high of around 70% of the index, while banks and insurers are at their heaviest weighting on the S&P/ASX 100 index in history.
The shake-up in the indices spells both danger and opportunity, according to WilsonHTM strategist, Damien Klassen.
“You’ve got a lot of small resources stocks that need to raise money to get their projects up and running, and their market cap is saying they are not going to get there,” he says.
On the other hand, bigger mining stocks dropping from a large cap index into a smaller one could be “buy” candidates as the relative size of these stocks mean they would constitute a fair proportion of the small cap index, which puts them on the radar of small cap fund managers.
However, these stocks won’t matter much to large cap fund managers who would be obliged to sell stocks that have fallen out of the big cap index as the stocks would only make up a small part of the top 100 or 200 benchmarks, explains Klassen.
Stocks that enter an index tend to attract support from fund managers, and that could bode well for iron ore producer Atlas Iron (AGO) and rare earth miner Lynas Corporation (LYC) as they are likely to be included in the small cap index as they are kicked from the ASX 100.
WilsonHTM has a “buy” recommendation on Atlas, with a price target of $1.08, but does not cover Lynas.
However, the average broker price target taken off Bloomberg for Lynas is 72 cents, which is close to 90% ahead of its current share price, although brokers are divided on their recommendation on the stock due to problems with its Malaysian facility.
Four out of five stocks that are likely to be dumped from the S&P/ASX 100 index are miners, while nine out of 11 demotion candidates are resource related stocks.
Meanwhile, the number of stocks on the ASX Small Resources Index (which is part of the S&P/ASX Small Ordinaries) is set to drop to 71 from 87, although Klassen notes that the weighting of the sector on the small ordinaries will increase as the market cap of Atlas and Lynas is greater than the mining minnows set to be expelled.
The irony of the index changes this time round is that promotion into a benchmark by S&P is not based so much on merit says Klassen. It’s just that these stocks have managed to hold their value better than mining stocks.
Nonetheless, it still pays to keep an eye on the comings and goings of stocks as the changes could help investors think about how to rebalance their own portfolios.