First half company reporting finished at the end of February. Results were robust, if not underwhelming. The market’s 5 per cent surge in February was helped by low expectations and suggest investors had feared worse. However, an extension of January’s impressive V-shaped rally in February (after a sharp sell-off in November and December) contrasts a further erosion in 2019 profit growth expectations to just 3pc.
So, we are wary that current market momentum may prove fickle, as it did six months ago after fundamentals were fully digested. Capital management upside was dominated by resource companies, while industrial companies appear to be holding back some dry powder given their challenging outlook. The market looks vulnerable to some profit taking, but we continue to identify opportunities among the noise.
Themes setting the tone during reporting season included:
Stable economic conditions but upside somewhat limited – Overall the Australian economy has remained stable with ongoing employment growth and higher commodity prices. Balance sheets have left capacity for companies to return cash to shareholders in special dividends and buybacks. However subdued business and consumer sentiment has manifested in weaker retail spend and housing softness.
Low expectations evident in price reactions – Best performers in response to results were dominated by beaten down names in challenged segments which reported results better than the market had feared. However, in most cases, this strength was not matched by upgrades to earnings.
Capital management takes centre stage – Capital management upside potential was a strong theme heading into February, particularly considering potential changes to franking credits. Upside surprise was dominated by the resource sector via special dividends and higher payout ratios.
High flyers still flying high – The wide valuation gap between value and growth led to a low margin for error among highly priced stocks. So, we were surprised when this section of the market continued to re-rate further. We view the risks as being even more asymmetric particularly in the context of slowing earnings momentum.
Cost inflation getting harder to ignore – We see widespread evidence of cost inflation across the market from regulatory and compliance costs (fallout from the Royal Commission) to input cost inflation (higher commodity prices and transport costs) to wage inflation. We think profit margins have passed their peak in this business cycle.
Past peak regulatory uncertainty – With the overhang from the Royal Commission into misconduct in the banking sector over, the earnings environment is gradually becoming clearer for the banks. Macroprudential measures have been wound back paving the way for an uptick in credit growth over coming months. The main uncertainties now relate to potential changes to negative gearing and a slowing housing market.
- Justin Still Investment Adviser (Authorised Representative: 000279726) Morgans Financial Limited | ABN 49 010 669 726 | AFSL 235410