Rudi's View | Feb 07 2019
In this week's Weekly Insights:
-February Reporting Season Preview
-Between A Graphite Rock And A Hard Place
-Rudi On TV
-Rudi On Tour
It's 2019, and we're back..!
February Reporting Season Preview
By Rudi Filapek-Vandyck, Editor FNArena
The public debate as to whether the US, and by extension the global economy, is heading for a recession has quickly fallen flat in early 2019. Very little works as reassuringly as rising share prices, and as the dire and gloomy final quarter of calendar 2018 has been followed up by one of the strongest January performances on record, investors worldwide seem to accept that maybe there still is a valid alternative in between raging bull and relentless bear.
One might be inclined to draw a parallel with early 2016. Things seemed similarly doomy and gloomy at that time, but the Federal Reserve, then chaired by Janet Yellen, got the message and pressed the pause button. By year's end the outcome for global equity markets turned out a lot better than many would have dared to predict at the start of the year.
I doubt whether 2019 will carbon copy the year 2016, though we do share Brexit on the calendar, and the RBA is patiently sitting on its hands. Global growth appears to be decelerating rapidly, with growing concerns about Europe and China, while indicators and data in Australia further highlight all is not well with construction of apartments and consumer spending.
For the local share market specifically this implies earnings forecasts and short-term valuations will need to reset at a lower level; a process that has already started ahead of the February reporting season. Analysts at stockbrokerages have been busy cutting estimates and price targets for a number of weeks. But many a share price is by now trading at a level well below last year's peak in August.
The Big Question for investors then becomes whether forecasts still need to be reduced further or whether share prices are already reflecting an outlook too dire for what likely awaits next?
The proof of the pudding, as the old saying goes, is in the eating. Corporate results, and in particular forward guidance provided over the following 3-4 weeks, will be submitted to extreme scrutiny, if only because many investment portfolios got dented, battered and bruised throughout the late 2018 turmoil, and investors will be anxious to avoid further disappointment.
Properly assessing this "earnings recession" is now on every investor's mind. Is it really as bad as (some) share prices are suggesting? Where are the likely surprises? How much risk is there still out there? Is it really worth trying to go contrarian?
Corporate reporting seasons overseas are only half-way through at the most, but observations to date suggest the US looks reasonably OK, while Europe has been rather disappointing. And Australia? Locally we don't have much to work with yet, apart from a few dozen negative profit warnings, mostly from small cap companies, plus a handful of early corporate result releases.
The February reporting season is still only warming up. The calendar gets busier next week, but in particular in the final two weeks of the month. Meanwhile, local investors have enjoyed higher share prices in response to a much more relaxed Federal Reserve, and on expectations of no escalation in tensions between the Trump administration and China; OK corporate results in the US have further supported general sentiment, as did the final Hayne report following the Royal Commission into banks and financial service providers.
Post its February Board meeting on Tuesday, the RBA's assessment included a downgrade of the economic outlook while highlighting additional downside risks, while still maintaining a positive outlook overall.
In terms of concrete signals from the corporate coal face, more than twenty profit warnings issued by small cap companies throughout December have been followed up in January with similar warnings from the likes of Investsmart Group ((INV)), Yowie ltd ((YOW)), Wagners Holding Co ((WGN)), McPhersons ((MCP)), Oliver's Real Foods ((OLI)), and Navigator Global Investments ((NGI)) in further evidence operational momentum late last year has run into a serious slow-down headwind for a number of Australian companies, in line with economic data and indicators.
The impact from the global slow-down is not restricted to small caps, as shown by recent profit warnings issued by Sims Metal Management ((SGM)), Boral ((BLD)), Costa Group ((CGC)), Platinum Asset Management ((PTM)), Kathmandu ((KMD)), and several others.
As far as actual corporate results are concerned, ResMed ((RMD)) and GUD Holdings ((GUD)) both missed market expectations and their share prices were sold down in response, quite savagely too with ResMed's US-listed shares losing in excess of -20% immediately after the quarterly update. Both are quality, resilient performers with a positive track record, and a longer-term growth path intact, which is probably why their share prices have somewhat recovered since.
The treatment of both "misses" however will have put experienced investors on notice: things can get quite brutal if corporate results somehow miss the mark. Fund managers will have responded by taking some share market exposure off the table, with the aim of slightly reducing risk and having the ability to respond to outbursts in short-term volatility.
Credit Corp ((CCP)) did perform better than expected, but forecasts and broker price targets didn't move that much higher, so the initial jubilation was quickly met by traders selling. That is the other kind of risk this month: maybe most of the good news is already in the share price?
The other scenario is, of course, a share price that is simply too low for whatever seems to be happening operationally. Here, investors can take heart from the market's response following an update by perennial disappointer James Hardie ((JHX)). While the quarterly performance continues to look subdued, management has announced a new cost reduction program and narrowed guidance for the full financial year. The share price jumped by 6%-plus on Tuesday.
Admittedly, the stock lost a big chunk of its value since August last year -some -37% on the back of two consecutive disappointing market updates- but the underlying message is nevertheless that some share prices at least have fallen too deeply.
Combine all of the above, and the February reporting season will inevitably become the first major litmus test for how corporate Australia is coping with the many headwinds and challenges. We can all believe, suspect, speculate and predict, but ultimately the financial numbers and their impact on market forecasts and sentiment will do the main talking.
Every reporting season has investors and analysts worried about at least one segment of the market and this time around the widespread concern is about the general deterioration in consumer spending, which is expected to weigh upon financial performances of discretionary retailers and automobile-related business models. But not all of them, of course, and not all of them to the same degree.