Challenging earnings outlook weighs on market

The ASX 200 is down 3.3 per cent since reporting began, making it the worst reaction to a reporting season – apart from the start of Covid-19 – since August 2019.

A challenging earnings outlook is one of several factors weighing on shares. Monday was typical of what has been a decidedly mixed December half-year reporting season.

TPG Telecom rose 5.9 per cent and Woodside rose 1.5 per cent after reporting, but Downer EDI shares dived 24 per cent, Appen dropped 14 per cent, InvoCare lost 11 per cent and Healius fell 4.1 per cent. Iron ore and lithium miners were hit by commodity jitters.

After falling 1.1 per cent to 7225 points, the ASX 200 index is still up 2.7 per cent for the year to date, but 4.6 per cent below its early February peak.

The index is down 3.3 per cent since reporting began, making it the worst reaction to a reporting season – apart from the start of Covid-19 – since August 2019.

The earnings period hasn’t engendered a huge amount of confidence in the ability of corporate Australia to increase earnings and dividends after aggressive interest rate hikes.

That’s particularly so as interest rate expectations continue to ramp up amid hawkish central bank rhetoric, resilient economic data and stubbornly-high inflation indicators in the US and Australia.

After US PCE inflation exceeded expectations for January and other economic data continued to beat estimates on Friday, market pricing implied three more 25 basis point rate hikes and the chance of a fourth by the Fed, to a peak of 5.4 per cent versus 4.62 per cent now.

In Australia, pricing implied just over four more 25 basis point rate hikes for the first time this cycle.

Goldman Sachs strategist Matt Ross said earnings showed “few signs of any significant slowdown in demand”, as 38 per cent of the top 200 “beat at the revenue line” and only 18 per cent missed.

But firms found it “much more challenging to pass on higher costs” with nearly 50 per cent of companies missing at the earnings line, well above a long-run average of 30 per cent.

Operating costs grew at a staggering annual pace of 14 per cent on average – a post-pandemic high – although most companies reported that cost pressures had likely peaked.

Earnings missed more frequently than normal, albeit they were typically small in magnitude and downgrades to consensus earnings have been no larger than average.

Highlighting the contrast between the top and bottom line, analysts upgraded their fiscal 2023 revenue forecasts for 75 per cent of the sharemarket’s 11 sectors, but cut their margin forecasts for all sectors bar health care.

“Overall ASX 200 industrials earnings per share growth for fiscal 2023 was only cut by 30 basis points to 6.2 per cent, but we expect it will continue to trend lower,” Mr Ross said.

Other things equal, a return to pre-pandemic margins would imply that aggregate forecasts for earnings per share growth in fiscal 2023 and 2024 need to fall by 5 and 10 per cent respectively.

Trading updates have been mixed, with a softer start to the year evident for most housing-related updates. Despite no strong signal that consumer discretionary spending peaked, consumers are becoming more value-oriented, making it harder for low-margin businesses to pass on costs.

Most firms indicated that input costs had peaked and were starting to ease, with lower commodity prices and looser supply chains, but labour costs were an exception.

Wages are still rising and labour shortages, while improving, are still a key challenge, especially in mining and construction.

Capex cost blowouts are a “consistent feature” and Goldman Sachs analysts have revised up their ASX 200 company capex forecasts for fiscal 2024 by about 5 per cent. Despite the more challenging cost environment, it was notable that very few firms have announced large lay-offs, unlike in the US.

“To us, this highlights that while businesses are struggling under a higher cost environment, for the time being they are still relatively confident about the near-term outlook,” Mr Ross said.

More broadly, while ASX 200 has fought back from a 14 per cent fall in 2022, high volatility is set to remain a key theme amid economic and earnings uncertainty, according to State Street Global Advisors.

“The economy is delicately balanced at the moment, with larger than normal uncertainty in the future path of company earnings and interest rates,” said Bruce Apted, SSGA’s Australian head of portfolio management for active, quantitative equities. “Central banks are walking a fine line with risks of being either too tight or too accommodative. While uncertainty remains for these elements, we should expect more wild swings in equity prices.”

Equity investors were “trying to look through the current earnings slowdown … (but) the longer the trend remains negative and the more uncertain the economic outlook, the harder it becomes.”

Mr Apted said Australian investors had turned more bearish in February as they assess trends in earnings and macroeconomic risks. They favoured lower volatility, better valued, higher quality and larger companies.