Times are a-changin'

Auction results from the weekend confirm what everyone is feeling – house prices are rising as demand outstrips supply. For the share market, this can be interpreted as a sign of being on the verge of an expansionary phase.

Recent news flow has been dominated by the looming US debt ceiling and how Congress is going to resolve the drama. Assuming a resolution is reached and financial markets don’t endure a meltdown in the meantime, investors could be closing the door on favouring investments for defensive qualities and yield on offer, spurring a sector rotation.

Rising house prices position the banking sector well. Generally speaking the sector is favoured through most of the business cycle, but more so in the early stages of an expansion as surging house prices add a new level of support to asset values. Since the last rate cut, the average gain of the big four has been 5.2 per cent, against a broader index gain of 2.4 per cent.

Yield offered on the banks has been whittled away as share prices have climbed, moving them back to be more growth plays in the eyes of investors. This is also tell-tale sign there is a change in the business cycle.

A turning tide will put currently ‘out of favour’ sectors back on the radar – industrials are one of these. Companies with a tilt to capital goods will be coming into their own as the business cycle progresses; possibilities include CSR Limited and Downer EDI.

Historically, retail stocks have done well in the early stages of an expansion as consumers spend more enthusiastically. Although business and consumer confidence is recovering, we have already seen a strong improvement in this sector of the market. Notables include JB Hi-Fi and Super Retail Group – share prices have gained 114 per cent and 56 per cent respectively over the past year.

The onset of this expansion brings about a markedly different set of conditions for retailers than they have experienced at the start of other expansions, noting a stronger domestic currency and weaker consumer confidence.

For retailers, their fate from here will come down to how freely consumers will continue to part with their dollars as current share prices conclude earnings must improve to warrant existing valuations. The persistence of the Australian dollar has potential to have retailers looking at discounting measures to move inventories once again, reducing profit margins.

Believers in the global growth story are not short of investment opportunities. James Hardie, through its building exposure in the US and Twenty-First Century Fox are well placed to leverage on as global growth continues to grind along.

Acknowledging the onset of an expansion means lightening the load to defensives, including the ever popular Telstra and real estate investment trusts, in favour of companies with a stronger leverage to the business cycle. Beyond this, selected healthcare and infrastructure investments would lose favour in the face of more upbeat times.