Mining and commodity large cap stocks represent an excellent long term buying opportunity, according to FE Alpha Manager James Henderson (pictured) who adds housebuilders are looking overvalued.
The long term manager of the Lowland Investment Trust, which he has run since 1990, thinks stocks such as Rio Tinto and Glencore which have suffered huge falls in recent years are likely to re-rate significantly over the medium term.
On the flip side he says those housebuilding stocks that have soared in recent years are starting to look expensive. He thinks these two trends will reverse in due course.
According to FE Analytics, Glencore and Rio Tinto have suffered huge falls over the past few years while housebuilders such Taylor Wimpey, Barratt, Berkeley and Persimmon have seen huge gains.
Performance stocks over 2yrs
Source: FE Analytics
Henderson says he is slowly adding to these two mining firms especially during the current market weakness despite expecting further pain for the stocks.
“What we are trying to do is on the 'red days' when you really wish you weren't in the office, we are buying some more,” he said.
“The thing about being contrarian and a recovery type manager is you are aware that you always move too early - I have always found that in myself so trying to do it in slow, small amounts over a reasonable period of time but still do it.”
“Especially when you really don’t want to do it, just buy a few more. When it is really red and horrid then do it and then reduce the stocks that really fashionable. When people feel really fashionable about a stock that is when a lot of it is in the price.”
He thinks housebuilders have become “too fashionable” and a consensus trade with high demand bidding up valuations to unsustainable levels.
“These companies are now expensive being on two times book value. They are well managed businesses but things are rarely as good as you’re told and they are rarely as bad as you're told.”
“A contrarian always keeps thinking that. You just have to be disciplined in how fast you move between the two things. Both things always go for longer and the last bit is always uncomfortable.”
Mining firms have fallen hard because of slowing economic growth in China coming at the same time the market woke up to the extent of capex overextension.
While global growth shows no signs of being rebounding, Henderson says the businesses have turned a corner
“In these sorts of downturns people re-learn their discipline. Rio Tinto is actually mining iron ore better, they are actually producing copper better than they were.”
“For the things they can control, they are doing better. That is what happens in a downturn. In upswings it is very easy to make money and people become ill-disciplined. We are seeing discipline return and we are using the investment trust ability to take longer view.”
However, Chris Beauchamp, senior market analyst at IG, thinks miners are struggling to make a real progress.
“What is becoming clear is that every ‘up’ day for their share prices is the cue for more embattled investors to sell, providing yet more downward pressure.”
The move back into commodity stocks does seem to have hurt performance for Lowland, with the trust down more than double the FTSE All Share’s fall in 2016.
Performance of trust, sector and index in 2016
Source: FE Analytics
However, over the longer term Henderson’s multi-cap approach with which he splits the portfolio into thirds of large, medium and small caps has contributed to Lowland’s significant outperformance.
The trust has returned 502.19 per cent over the past 20 years compared to 255.07 per cent from the IT UK Equity Income sector average. The FTSE All Share has gained 239.06 per cent over the same period.
Performance of trust, sector and index over 20yrs
Source: FE Analytics
Our data shows that Lowland has tended to fall and rise much harder than the market. In 2008, for example, Lowland lost close to 50 per cent while in 2012 it made nearly 50 per cent.
Lowland is the worst performing portfolio in its sector this year, which is its worst relative and absolute performance since 2008.
However, it is still ahead of the index over three, five and 10 year periods.
Its top 10 holdings include large caps such as Royal Dutch Shell, Provident Financial, BP and Shell as well as small caps such as Senior, Hiscox and Scapa.
The £439m fund is trading on a 4.3 per cent discount. The trust currently yields 3.5 per cent.