Brace for volatile reporting season, warns Morgan Stanley

Morgan Stanley warns of a potentially volatile reporting season as consensus estimates for earnings are tested after a strong three-month rally caused by plunging bond yields.

Morgan Stanley warns of a potentially volatile Australian earnings season after a strong three-month rise in stocks fuelled by sharply lower bond yields as central banks pivoted away from rate rises.

Led by a 20 per cent rise in the S&P 500, driven in turn by the Magnificent Seven tech giants that have limited read through for Australian companies, the local S&P/ASX 200 index has climbed 13 per cent from a late October low to a record high of about 7700 points, exceeding most forecasts for the year.

Notwithstanding some pushback against imminent rate cuts by central bank officials as inflation remains above target levels in developed economies, investors have priced in multiple rate cuts in the US, Europe, Australia and New Zealand, and hold hope of meaningful stimulus in China, underpinning stock valuations and the outlook for economic growth and earnings.

But as the economic impact of past rate rises continues to be felt and pressure on margins is expected to intensify for some industries, Morgan Stanley says a “rising tide” in the stockmarket has “lifted all boats”, while earnings forecasts and consensus ­ratings can be “somewhat stale”.

“The strong finish to the year has left investor debate finely balanced around durability and catalysts for further upside,” says Morgan Stanley Australia equity strategist, Chris Nicol.

“Our view remains that there is more stock-specific risk/volatility after a rally that has lifted most boats, so being better prepared for the messages in bottles seems prudent.”

His comments come as the pace of reporting picks up on Thursday with a string of major companies including AGL Energy, Cleanaway, Mirvac, NBN Co, News Corp, REA Group and Transurban due to report.

To find companies where upgrades are on the cards unless results reveal negative catalysts, Morgan Stanley lists those for which more than 50 per cent of analysts have hold or neutral ratings, yet their stock prices are more than 5 per cent below their respective consensus targets.

“Getting the neutrals right can be a rewarding exercise to capture alpha, so screening consensus holds with a degree of implied upside is a good place to start the search,” Mr Nicol said.

That list includes Atlas Arteria, AMP, APA, Aurizon, Bega Cheese, Challenger, Charter Hall Long WALE REIT, Domain, Downer, Healius, Incitec Pivot, Mirvac, Qube, Ramsay Health and Technology One.

A second list compiled by the US bank looks at companies for which more than 50 per cent of analysts have buy or overweight ratings, yet their stock prices are less than 5 per cent below their targets. “Here results season looms large as valuation conviction appears in need of a catalyst,” Mr Nicol said.

Major companies in that list include Rio Tinto, Goodman, Macquarie Group, James Hardie, Scentre Group, Stockland, Seven Group, Washington H. Soul Pattinson, BlueScope Steel, Medibank, Premier Investments, Ampol, TPG Telecom, Flight Centre and ALS.

With 42 of the top 200 companies on those lists, there are clearly a lot of companies for which consensus estimates for earnings and ratings are stale. Hence, the potential for volatility stemming from earnings updates and outlook statements over the next few weeks.

Morgan Stanley’s Mr Nicol also listed a number of “macro” and “micro” influences or themes to watch for this reporting season.

On the interest rate outlook, he said the narrative that companies attached to the outlook for monetary policy and potential impact on trading conditions was “likely to have shifted quite mat­erially” since August, and management conviction on the outlook could “change to cyclical opportunity versus entrenched caution that has been typical of much of the last two years”.

With the already-legislated stage 3 tax cuts changed to give a greater spread of distribution and importantly boosting income cohorts with a greater propensity to spend, he expects consumer-facing companies to give context around how it will affect their earnings outlooks.

On the flip side, another policy influence to watch for will be commentary around impacts of the introduction of the Fair Work Legislation amendment. Tranche one was passed into law in ­December last year, “closing the labour hire loophole” provisions that create potential obligations for labour hire employers and “hosts” that rely on their services among other changes.

It is part of a three-tranche legislative agenda that has been met with significant pushback from various industry groups. These IR policy changes are likely to feature in company narratives.

China will be another talking point as its outlook has evolved rapidly in the past year, from reopening to stimulus hopes to the more recent worry over structural deflationary risks.

“In August 2023, results transcripts showed limited reference to China’s outlook and influence,” Mr Nicol said. “However, with a 2024 outlook carrying a heightened degree of execution uncertainty, we watch for any pick-up in reference to challenges and growth impacts.”

The weather could also be an issue for agricultural, building materials and insurance companies. Mr Nicol said the weather experienced had been “counter to expectations” and the significant flooding and storm ­activity that ensued were a “surprise to many”.

“Now, with forecasters already shifting to a focus on whether a La Nina episode is looming, this results season will provide insight to impacts on insurers, food supply chains and resource sector activity,” he said.

Migration was an important support to economic growth, particularly spending growth in 2023. In the year to the end of the third quarter, the entirety of the real increase in household spending was contributed by nonresidents, Mr Nicol noted.

He expects migration to provide a smaller tailwind to spending growth this year, with net migration expected to ease from a 500,000 annual rate last year to about 330,000 in 2024.

While still above the pre-Covid run rate, an expected fall in population growth from 2.5 per cent to 1.8 per cent a year could influence many domestic-facing sectors.