A choppy end to 2018 saw the ASX200 fall 9 per cent over the December quarter, although around half of those losses have since been recovered in January. Valuations have de-rated sharply, leaving the ASX200 trading in line with its historical average of 14.4 x 12-month forward price earnings for the first time since 2014.
Low expectations could be a blessing in disguise
Recent volatility has set a cautious tone, but stocks enter the February reporting season with far lower expectations upon them and at attractive valuations not seen since 2014. Elevated valuations have proven to be a difficult hurdle over the past reporting seasons with many high price earnings names stumbling by failing to deliver on high expectations. Those expectations are now far lower heading into February. Hence we think recent weakness is also a tactical blessing for investors capable of looking through macro uncertainty, who were waiting for more attractive entry points.
We’ve seen a steady stream of profit downgrades among Australian industrials into early 2019, skewed toward companies exposed to the slower housing/construction market, retailing and domestic cyclicals. This has contributed to the market’s weak end to 2018.
The aggregate profit growth forecast for Australian industrials has steadily eroded over the past 12 months to a tepid 4.7pc. The erosion of expectations is consistent with recent periods where the market has over-estimated the recovery of Australian corporate profits.
Offshore earnings vs onshore
Real United States GDP rose at a blistering 3.8pc average annualised pace in the second and third quarter of 2018. There is no way that sort of growth rate could have been sustained. Financial conditions in the US have tightened sharply in the fourth quarter, which has weighed on growth. The New York Fed GDP points to forecast growth of 2.5pc in the fourth quarter of 2018 and 2.1pc in the first quarter of 2019. This will bode well for offshore ASX listed companies such as Corporate Travel (CTD), Reliance Worldwide (RWC) and Aristocrat Leisure (ALL).
While Australian economic growth is not to be scoffed at, offshore markets continue to outpace domestic earnings. We expect to see companies further clarify the extent of the US moderation in growth at the result and we do see some upside risk from a better than expected quarter in US earnings.
Recent commentary from management continues to reflect an overall positive environment. JP Morgan earnings call for their fourth quarter 2018 states: “Economic indicators remain upbeat and given the breadth and depth of our franchise, we have a pretty good barometer. From everything we see, the US consumer remains very healthy.”
A franking credit sugar hit?
Tactical investors may benefit from an environment where corporates with large franking balances could bring forward plans to buy-back shares and pay special dividends, ahead of potential changes to franking. Key candidates to release surplus franking credits include Woolworths (WOW) and Wesfarmers (WES).
Tactical positioning into February
We think that avoiding the downside is as important as identifying the upside in the current climate. The good news for investors is that stocks are cheap, and enter reporting season with a far lower bar to clear in terms of market earnings expectations. That said, we think the risk of upside revisions through February appears limited given recent trends in earnings forecasts.
- Boh Burima Financial Adviser | Authorised Representative: 000341081 Morgans Financial Limited | ABN 49 010 669 726 | AFSL 235410