All signs point toward bumper earnings season

Investors are looking past Covid lockdowns in assessing corporate earnings. Picture: AFP

Sharemarkets in the US and Australia are hitting record highs despite a resurgence of Covid as increasing vaccination rates give investors reason to look past short-term earnings impacts.

After only shallow dips last month as Covid infection rates increased, both the S&P 500 and the S&P/ASX 200 have hit new records, encouraged by the fact that 88 per cent of S&P 500 companies have reported positive earnings surprises for the June quarter.

UK evidence that widespread vaccinations can prevent surging hospitalisations and deaths is also reassuring, but the extended lockdowns in NSW and potential snap lockdowns in other states adds uncertainty to the earnings outlook for domestic-facing cyclicals.

There has been some wariness about travel companies, discretionary retailers and real estate investment trusts which could struggle to give earnings guidance, although banks have found support from share buyback plans from ANZ and NAB, with others expected to follow.

GUD Holdings said the demand environment was “too dynamic” to provide reliable earnings guidance and its shares fell 3.3 per cent on Wednesday.

The ASX 200 rose 0.4 per cent to a record high close of 7503.2 after similar gains on Wall Street.

JP Morgan’s head of research, Jason Steed says lockdowns are “once more casting a long shadow of uncertainty over the outlook for corporate Australia”.

“The first casualty will be guidance, which, much like August 2020, will be pared back or dispensed with altogether,” he says. “Qualitative outlook statements are bound to be highly circumspect.”

But despite this inauspicious backdrop, he expects underlying earnings trends will remain strong.

JP Morgan’s bottom-up consensus for fiscal 2022 net profit is 9 per cent above consensus.

“What’s more, earnings revisions remain positive, with breadth still near all-time highs,” Steed says.

“In addition, dividend projections have recovered all of the past year’s lost ground and on a year-on-year basis are now running ahead of the globe.”

He also notes the “intensification” of M&A activity “remains in full swing” after news of a record $39bn bid for Afterpay and a $22bn merger of Santos and Oil Search on Monday.

“In light of these factors, our 12-month outlook remains positive, albeit anticipating some turbulence in the coming weeks as the Delta lockdown blues persist.”

Importantly, revisions remain comfortably in positive territory, with the strongest year-to-date rise in earnings expectations since the global financial crisis.

“While management teams are bound to be guarded when providing guidance, we see clear grounds for upward momentum to continue, albeit with the spate of lockdowns causing some transitory turbulence,” Steed adds.

But with the Delta variant a “greater threat than first thought”, JP Morgan economists have downgraded their growth expectations despite high vaccination rates in Europe and the US. Still, the June quarter reporting in the US and Europe has been “very strong”, leading JPM strategists to upgrade their S&P 500 year-end target from 4400 to 4600 points.

And after analysing US earnings season, Macquarie equity strategist Matthew Brooks thinks “Covid losers” can do better than “Covid winners”.

“While the risk of lockdowns and a delayed recovery continues until Australia has a higher level of vaccinations, we still think investors should be overweight Covid losers as their earnings recovery should outpace market growth,” he says.

In the US earnings season, Covid losers have actually had stronger post-reporting share price gains than Covid winners, with some of the strongest post-result returns coming from “reopening trades” like restaurants and hospitals.

But Brooks’ “best long ideas” into reporting season are skewed to defensive stocks including Amcor, Brambles, Coles and Transurban, as well as others like Afterpay, Charter Hall, ResMed and Seek.

He also likes capital return stories in cyclicals including Ampol, BHP, Deterra and Fortescue.

BlueScope Steel and Eagers have been cut from his “best ideas list” as they already pre-announced positive earnings in line with his team’s thesis.

Short-selling ideas include Domino’s Pizza and Suncorp, although the broker does have an outperform rating on Suncorp for a 12-month view.

His best “counter consensus calls” include Charter Hall, ResMed, Seek and Afterpay.

Macquarie sits above consensus on their earnings outlook for fiscal 2022, and Brooks notes that those consensus estimates have been rising in recent months.

He said 72 per cent of June quarter results from reporting S&P 500 companies have beaten consensus estimates by 5 per cent or more and only 4 per cent have missed.

That’s a “positive sign” for ASX 200 results, especially given the strong net beats in US financials.

Macquarie’s “bottom-up” fiscal 2021 earnings per share market growth estimate is 28 per cent.

After adjusting for the normal level of “beats” relative to consensus estimates, it could be over 30 per cent, but is then expected to slow to 11 per cent growth in FY22.

“With central banks slowly moving to tighten policy – which is a headwind for valuations – we still think investors should expect lower stock returns and more volatility,” Brooks says.

Looking ahead, he expects offshore income earners – led by the iron ore miners – to generate earnings per share growth of 36 per cent on average in FY22, more than triple the overall market.