Interest rates high for longer but demand outlook improving

Australia’s August results announcements are giving hope of an earnings recovery linked to an improving demand outlook despite higher interest rates.

After hitting a record high of 8148.7 points at the start of the month, the S&P/ASX 200 index fell as much as 6.4 per cent to a two-month low at 7628.1, but has since recovered. Picture: Getty Images

Australia’s August reporting season it is giving hope of an earnings recovery linked to an improving demand outlook, even as sustained high interest rates are having mixed impacts.

To be sure, the global risk appetite has had more impact on the local sharemarket than reporting season so far as the market has gauged the chance of a US recession.

After hitting a record high of 8148.7 points at the start of the month, the S&P/ASX 200 index fell as much as 6.4 per cent to a two-month low at 7628.1, but has since recovered to 7980.4.

With reporting roughly a third complete by number and half done by market capitalisation, net positive earnings surprises and a slight downgrade of the earnings outlook have dominated.

Supported by improved profit margins, the “beat-to-miss” ratio for corporate profits has been a relatively healthy 19 per cent, and there’s been a positive skew in share price reactions.

“With equity sentiment more balanced, we could continue to see a positive skew as investors position for interest rate cuts,” Macquarie’s Australian equity strategist, Matthew Brooks said.

But amid uncertainty over the outlook for interest rates and the US election, there have been many more misses than beats in terms of guidance for the 2025 financial year when using a 5 per cent threshold.

Despite all the profit beats for FY24, the ratio of consensus downgrades-to-upgrades for FY25 was two to one when using a 5 per cent threshold, with downgrades across sales, margins and dividends.

Of course, whether this guidance turns out to be conservative depends on the timing of interest rate cuts and how much unemployment rises.

Cyclical retailers JB Hi-Fi and Temple & Webster were standouts last week, beating expectations for financial year 2024 and also delivering rare upgrades to current year guidance.

Brooks said it’s too early to say if this reflects execution or an improving consumer.

Media was the weakest, with misses from Seek and Seven West.

With slightly more downgrades for bigger companies, Macquarie’s bottom-up estimate for FY25 earnings per share growth fell 50 basis points to a modest 4.0 per cent.

“While the high share of beats is positive, we would caution against extrapolating this trend to the rest of reporting season,” Brooks said.

The positive surprise so far has been driven by small caps and cyclicals, but earlier results also tend to have a higher share of quality companies. Reporting season often saves the worst for last.

But while the total of consensus expectations for FY25 profits has fallen 0.8 per cent, this is in line with the average downgrade of 0.8 per cent during reporting seasons, according to MST Marquee.

“There is growing evidence that the low in Aussie domestic demand growth is now behind us,” senior analyst Hasan Tevfik said.

“Last week survey data from ANZ and Westpac revealed an improvement in consumer sentiment … and providing further evidence of a fledgling recovery in domestic demand are the trading updates by Australia Inc.”

MST Marquee senior analyst Hasan Tevfik. Picture: Julian Andrews

Updates from consumer companies showed July trading conditions were overall “solid”.

Driving a likely improvement in domestic demand so far in FY25 are the stage three tax cuts, worth $20bn or around 0.8 per cent of GDP, plus electricity rebates from federal and state governments which will boost these two forms of fiscal expansion to beyond 1 per cent of GDP in financial 2024.

“It appears the RBA is now adjusting to stronger government demand and this is where their biggest upgrades were in the most recent Statement of Monetary Policy,” Tevfik said.

“While there are pockets of weakness in domestic demand, as highlighted in the CBA result with arrears on the rise, the aggregate outlook is one of improvement.”

After falling 7 per cent on-year in the December 2023 half year, aggregate EPS is expected to have fallen 6 per cent in the June half year, before picking up to flat in the December 2024 half year.

“As we look ahead to Dec 2024 we should see clearer signs of a less bad profits backdrop and year-on-year growth by this time next year,” Mr Tevfik said.

Much of the weakness has been in resources, while industrials’ profit growth has slowed.

Industrials have seen the weakest reporting period so far amid disappointments from the likes of CSL, Origin and Seek. However their growth in FY25 is expected to be the best of the ASX sectors.

Financials have had the best reporting period net, with interest margins holding up for CBA.

“If there is one clear takeaway from results thus far, it is that for both companies and householders, the ‘higher-for-longer’ interest rate environment is impacting,” UBS Australia equity strategist, Richard Schellbach said.

“This shouldn’t come as such a surprise, given an extended interest rate plateau is something we have been warning on for some time. But for many it is driving change, as their once dovish interest rate expectations are having to be scaled back further into 2025.”

But in reality higher-for longer rates have both positive and negative implications for stocks.

“For banks, the positives so far seem to be winning out, with both CBA and National Australia Bank reacting favourably to the stabilisation seen in their net interest margins,” Mr Schellbach said.

There may be a sting in the tail, however, as rising non-performing loans may fuel bad debts.