Reporting expectations low

Reporting season expectations low

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Stocks enter the August full year reporting season with very low expectations for 2019 on aggregate.

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Justin Still

Justin Still

What a difference six months has made. At the end of last year, the Australian market had fallen about 15 per cent from its August high and the US market was down 20pc, with the US Federal Reserve having lifted interest rates and the expectation was for a further three rate increases in 2019.

Fast forward to January and the US Federal Reserve did a backflip on interest rates, saying that there wouldn't be any further rate increases this year and the central banks' tone has changed to potentially now cutting rates. This has fuelled a sharp rally on markets with the Australian market this month finally breaking through its all time high reached in 2007.

Stocks enter the August full year reporting season with very low expectations for 2019 on aggregate. Expectations for 2019 earnings per share growth (excluding resources stocks) have eroded from around 4.7pc post February first half results to only 1pc heading into August. So, while we think that results can clear this low hurdle for 2019, we worry about: 1) current consensus full year 2020 earnings per share growth expectations looking too heroic at about 8pc; and 2) aggregate industrials valuations at a decade high 17.5 times price to earnings, leaving little room for error in 2020 outlook commentary versus market consensus expectations.

Lower rates have again fuelled what we call the 'yield' trade, that is investors looking for income. A mix of slowing economic growth, interest rate cuts and companies dialling back expansion capex have created an ideal environment for yield investors. We think upside surprise to capital management may again feature in August. Investors have sought returns in defensively oriented names since the February reporting season. However, we're uneasy about this dynamic in the context that earnings per share expectations, which support dividends per share expectations, have continued to erode. Pay close attention to the sustainability of future capital returns.

A trend over the past two to three years has been the outperformance of growth oriented stocks vs value stocks, highlighting high price to earnings stocks re-rating further against the pool of lower valued stocks. The spread is now 18 prices to earnings points vs the 10-year average of 10.

A slowdown in the economic climate and falling interest rates have contributed to the appeal of growth, extending valuations further. However, as the focus turns to domestic earnings and given expectations are higher than ever, we could be nearing the cyclical turning point. We think that avoiding the downside this reporting season is as important as identifying the upside in the current climate.

  • Justin Still Investment Adviser (Authorised Representative: 000279726) Morgans Financial Limited | ABN 49 010 669 726 | AFSL 235410
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