We entered the last reporting season in August 2018 with a high degree of optimism. That optimism was very short-lived as markets experienced a sharp sell-off in August, with actual results falling short of previous forecasts. Subsequently, news headlines have kept investors in a pessimistic mood, examples being the ongoing Brexit uncertainty and the ever-present threat of global trade wars.
What can we look forward to, or not, in the upcoming reporting season, bearing in mind that most companies will only be reporting their half year results.
Investors will be looking for the half time corporate score card and how that relates to previous guidance. Instant market favourites are likely to be those companies that deliver above guidance and reinforce that trend in the second half. Market pariahs are likely to emerge amongst companies that under-deliver on expectations. A miss on expectations is likely to undermine the markets faith in an underperforming company’s guidance and lead to a swift and negative price reaction for those falling short.
So let’s have a look at the numbers as they stand now.
In terms of valuations, the market’s price-to-earnings (P/E) multiple has dropped to 14x from its recent peak in August 2018. Either this means the market is a relative ‘bargain’ and a subdued earnings season could actually draw a line in the sand from which the market could drift higher. Or, and this could be a big OR, the earnings part of the P/E equation is too high and a poor set of earnings season results will be the catalyst for downward earnings revisions. This, in turn, will put pressure on share prices.
On the economic front, macro conditions appear to be stabilizing having recently being part of the volatility ‘problem’.
In relation to the S&P/ASX200, the ‘top end of town’, downside risk to the upcoming reporting season dominates. J.P. Morgan estimates that stocks in this universe with downside risk has risen from 17% leading in to the August 2018 reporting season to nearly 29% heading in to this reporting season. A worrying trend if realised. This compares with only approximately 24% of companies having expected upside risk.
The same holds true for the Emerging Companies where only a select few are expected meet or exceed market expectations and at the same time provide a solid outlook as the significant de-rating of many stocks within this group continues. Merger and Acquisition activity within this group may keep any price declines in check as perceived value emerges.
As it should be, investors will be bringing a renewed focus to those high quality businesses with strong cash flows and certainty of earnings. Fundamentals will start to re-exert their dominance and companies who have been supported by unrealistic inflation and growth expectations will lag.
Upcoming Bank and Financial Services company earnings will clearly be overshadowed by the Royal Commission findings, which ironically may provide some certainty.
The Resource sector outlook is mixed, but those with strong balance sheets (most) and robust cash flow will be well supported by investors. Consumer Staples are likely to deliver defensive earnings outcomes this reporting season.
However, the ‘elephant in the room’ event for markets in post reporting season 2019 will be the Federal election and to a lesser extent, the NSW state election. These events will be on investors’ minds as they assess the earnings results. There will be concerns around some possible policy changes like Capital Gains Tax (CGT) discount, negative gearing and franking credit refunds. That said, it is likely that the election results, if conclusive (i.e. a majority) will bring more certainty through stability. Political stability allows companies to make decisions and invest with certainty for the future.
Based on the trend of results from the upcoming earnings season, 2019 could be a better year for investment returns in the Australian share market. Attractive valuations, solid and maintainable dividend yields, strong balance sheets and a returned focus to quality, cash flows and fundamentals should provide investors with the tools and opportunity for improved returns. Let’s hope so!