As we continue to see volatility and negative returns posted in most major global indices, we figured it is an opportune time to provide some insight (thanks to our partners at eQR securities) into the impending reporting season.
It’s not uncommon to see heightened levels of volatility around reporting seasons, as investors scramble to digest the host of information provided by companies in regard to the health of balance sheets, market segments and the economy more broadly. However, the start of 2016 has been characterised by heightened levels of market volatility as a result of uncertainty over interest rates, with the US now at the end of its rate easing cycle while China is closer to making further cuts, and the outlook for global growth.
This is compounding what is already a difficult business cycle domestically with our two largest sectors – Banks and Resources – continuing to face challenging structural headwinds.
As a result, we’ve seen a raft of earnings downgrades heading into the February reporting season as analysts factor in escalating capital concerns for the Banks and account for weaker commodity prices across Resources. This has led to expectations for FY16 earnings per share to now go backwards from FY15.
…..but is this now priced in?
Despite the volatility, downgrades to earnings expectations and sharp share price declines to kick start the year, Don’t Look Back in Anger as we don’t believe that any of this is new news and we see the recent pullback in our local stocks as providing a fair(er) valuation.
This is particularly evident when comparing our local stocks to other asset classes with the dividend yield continuing to look attractive. Additionally, over the past 2 years, the ASX200 hasn’t been able to match the returns of its global peers but with our market now trading on a one-year forward P/E that is 2.2x lower than the S&P 500, and a lower AUD, Australian stocks should, in our view, offer some compelling value for global investors as well.
Where could earning growth come from?
With few catalysts to drive upside for domestic earnings, we expect the themes in February reporting season to be similar to those seen in FY15, with benign earnings growth leading to ongoing cost reduction efforts. As we head further into the cost cutting cycle, we expect earnings margins to be negatively impacted during these upcoming results and we will be looking for signals of how much further this can actually go before companies begin to erode revenue.
We do however see some pockets of opportunity across sectors such as Consumer Discretionary, where lower petrol prices, low interest rates and a buoyant labour market has led to some stabilisation in consumer confidence and a lift in disposable incomes. Additionally, the Health Care sector should continue to be a beneficiary of a lower AUD, while consolidation and large transactions across transportation and infrastructure could help lift revenue for Industrials and see a continued period of outperformance. Also, with bond yields set to remain lower, this may also further support A-REITs, even though parts of the A-REIT market look fully priced.
We understand that there is currently some concern amongst investors, however at times like these it is good to look to the greater investor of all time for advice, Warren Buffet. Here are two of our favourite Warren Buffet quotes to bear in mind as we continue to navigate choppy waters:
“No matter how great the talent or efforts, some things just take time. You can’t produce a baby in one month by getting nine women pregnant.”
“Our favorite holding period is forever.”