Earnings season and RBA meeting may test Aussie share market

Reporting season, inflation data and the Reserve Bank board meeting may test our share market valuation after it had a free kick from money flowing out of tech giants.

In the past three days the ASX dipped to 7900 as the US stock market selloff broadened Picture: Getty Images via AFP

Reporting season, inflation data and the Reserve Bank board meeting may test Australia’s share market valuation after it had a free kick from money flowing out of tech giants in recent days.

The S&P/ASX 200 rose as much as 3.4 per cent to a record high of 8083.7 after the Magnificent 7 index of US mega-cap tech stocks peaked two weeks ago, prompting a rotation to parts of the market that could benefit more from rate cuts than the tech giants.

But in the past three days the ASX dipped to 7900 as the US stock market selloff broadened.

That level should be strong support on the charts but there are challenges ahead.

Fuelled by surging earnings from the AI-boom, the Mag 7 index had soared as much as 43 per cent since the start of the year, driving more than 60 per cent of a 19 per cent rise in the S&P 500.

US rate cuts remain very much in play with 2-3 cuts of 25 basis points in the Fed funds rate expected by year end. However, volatility is rising as the US Presidential race heats up and has potential to put a blowtorch on valuations in the US and Australia at times over the next four months.

The VIX index of volatility on S&P 500 futures soared above 17 per cent on Friday after hitting a post-pandemic low of 11.52 per cent in May, a move that may force some funds to hold less equities.

US political uncertainty eased a notch on Monday after Joe Biden withdrew from the Presidential race and nominated Kamala Harris.

The US dollar retreated marginally, the US Treasury bond yield curve “bull flattened” and S&P 500 futures rose about 0.3 per cent in Asia-Pacific trade.

Analysts say a stronger Democratic candidate means a closer election outcome that lessens the risk of a so-called “red-wave” that could see Donald Trump boost trade tariffs, while not giving the Democrats enough support for a “blue-wave” that leads to higher corporate taxes.

But with the S&P/ASX 200 up 4.4 per cent this year while the consensus estimate for aggregate next-12-month earnings has fallen about 5.5 per cent, the PE multiple of the index has jumped from about 16 to 17 times, about 15 per cent above its long-term average PE multiple of about 14.8 times.

“The base to bull channel in which the index has been trading since last November has been sustained, but it has not been an earnings driven rally – it’s been all about price and multiple expansion,” Morgan Stanley Australia Equity Strategist Chris Nicol said.

This is “all well and good should an earnings recovery be just around the corner”.

However, “the elusive trough in market earnings is proving hard to find”.

After soaring from pandemic-era lows in late 2021, the consensus estimate for aggregate next-12-month earnings per share for the ASX 200 has fallen about 17 per cent since late 2022.

As analysts like to say in these situations, the market needs to “grow into its PE multiple”.

With the domestic earnings season kicking off this week, analysts will soon be in a position to judge whether this will be the case and more importantly how long it will take.

“The long lags of monetary tightening have finally caught up and domestic trading environments are weaker than what would have been expected in February,” says Morgan Stanley’s Nicol.

“Earnings estimates have been catching up with reality and we do expect the upcoming August results season to present some further risk – meaning that market EPS growth rates may well hold mid-single-digit profiles but the base will be lower.”

US rate cuts could trigger further flows out of US mega caps into Australian shares in coming months, but for domestically-facing stocks and potentially the broader market, a soggy earnings trajectory could be compounded if predictions of an August hike by the RBA eventuate.

“Here outlooks would most definitely be tempered and the earnings recovery that the market is now well and truly pricing would be pushed out into calendar rather than fiscal 2025,” Nicol said.

Earnings growth for Australian banks in particular looks “anemic” for financial 2025.

J.P. Morgan cut ANZ to Neutral on Monday. Macquarie downgraded Goodman Group.

“Indeed, small-mid cap forward growth rates are higher than large caps in general,” Nicol said.

The materials and energy sectors together account for about 25 per cent of ASX 200 market cap so commodity prices matter and energy price forecasts in particular are a large driver of market-level growth for financial 2024.

With the notable exception of gold, most commodities have come under pressure from China’s faltering economic growth in recent weeks.

Morgan Stanley’s Nicol noted that since the start of the year sectors with higher levels of consensus EPS estimates included Discretionary, Energy, Financials, and Utilities, while those with weaker levels included Healthcare, Technology, and Real Estate.

Three-month trends in earnings estimate revisions now favours the Consumer Services, Transport, and Utilities sectors, while those trends are weaker in Healthcare, Staples, and Real Estate.

Stocks trading at a premium to relative valuation history with negative earnings estimate revisions include CBA, REH, BSL, SHL, and WES, while stocks trading at a discount to relative valuation history with positive earnings estimate revisions include CSL, RMD, WHC, NEM, and XRO.

As for what stocks to buy in the Australian share market for US exposure if the so-called “Trump trade” takes off despite the likely Democratic nomination of Kamala Harris next month, Macquarie Equities likes Block, Light & Wonder, ResMed, CSL and Amcor.

Other Outperform rated ASX-companies at Macquarie with over 50 per cent of their earnings coming from the US are Pro Medicus, Polynovo, James Hardie, Orora, Reliance and Megaport.

But Macquarie Equities warns that the past three US elections took place in “expansions” and US stock returns were over 20 per cent in year one. This election takes place in a “slowdown”, and in these cases average post-election returns are below the long term average, Macquarie said.