Rudi's View | Aug 08 2019
Dear time-poor reader: preview to the August reporting season, and a video appearance, plus (in Part Two) Conviction Calls, and an update on the CSL Challenge.
In this week's Weekly Insights (published in two parts):
-August Preview: Lower Rates & Lower Growth
-CSL Challenge: Brief Update
-Rudi On Tour
August Preview: Lower Rates & Lower Growth
By Rudi Filapek-Vandyck, Editor FNArena
Coming into the August reporting season Australian equities had enjoyed seven months of uninterrupted gains, despite more than 250 profit warnings from ASX-listed companies and with underlying corporate profits (ex-iron ore miners) negative and in decline.
But central bankers are cutting interest rates and reassuring investors they remain ready to act whenever necessary. Combine all of the elements and it was always going to be an open question as to how investors would respond to benign profit results and (most likely) cautious guidance from Australian companies.
In the absence of real and tangible improvement on the ground, but with the prospect of rate cuts triggering a turnaround for Australian housing, and related spin-offs in the domestic economy, investors had been inclined to find "value" in beaten down sectors such as building materials and consumer spending.
But how much leeway would be granted to these companies in case August were to deliver no concrete signals of an actual turnaround?
We will never know the answer as the overriding theme in the first seven days of August has been a resumption of tit-for-tat hostilities between the Trump administration and China, putting the world on notice this battle between the two global economic giants is not about to be resolved amicably or soon.
All of a sudden investors can see the scary prospect of a recession on the horizon, and they are voting with their feet.
All at once heading for the exit door; it ain't a pretty looking picture. And on Tuesday, when I am writing these sentences, the local share market certainly is showing its ugly side.
We might all have had a sense, an inkling, that deep feeling that, maybe, August wasn't going to be just about corporate profits.
Well, our sixth sense has been proven correct. But whereas previously, when things looked a lot rosier from the hilltop with no clouds surrounding, investors might have chosen to grant companies the benefit of potential improvement on the horizon, the concern now has to be that the general turn in sentiment means no prisoners will be taken, and investors might elect to sell first, and revisit later.
If ever one wanted to study the importance of confidence and sentiment for financial markets, August 2019 might be the ideal starting point.
Australia Is Enjoying Growing Profits, But Is It?
Let's start off with the basic ingredients. The Australian share market is one of few worldwide that has enjoyed improving profit growth projections in the first half of calendar 2019, which should be a positive and supportive of its relative outperformance during the period.
But dig deeper and it is all about iron ore. Ex-iron ore, the trend is negative as is projected growth for the rest of corporate Australia, including the all-important banks. Hence, it looks positive from a distance, but it actually isn't.
The more bullishly inclined investor might counter that low expectations means companies are facing a lower hurdle to "beat" during reporting season. The more realistic approach, I believe, is to take into account that expectations are low for very good reason and it is no coincidence this reporting season has been preceded by what most likely has been the largest number of profit warnings recorded post-GFC in Australia.
Baillieu Chief Investment Officer Malcolm Wood has a slightly different set of numbers, but his message sounds remarkably similar. Baillieu counted 63 profit warnings from major ASX-listed companies since early April, representing circa 15% of the ASX100 and 14% of the ASX300.
Discretionary and housing-related sectors have dominated the downgrades in corporate outlooks, but all-in-all the softness has been broad-based on Wood's observation. Profit warnings have been issued by Village Roadshow and Speedcast International, as well as by Ainsworth Gaming, AGL Energy, Flight Centre, Costa Group, Viva Energy, McMillan Shakespeare, Syrah Resources, Citadel Group, Link Administration, Gold Resources, and many more.
In recent trading sessions investor sentiment had been shaken by further warnings from Adelaide Brighton, Graincorp and Bega Foods.
Observation: up until August successful investing in the Australian share market was closely correlated with avoiding profit warnings. This month, however, investors are facing the additional conundrum that market forecasts for the year(s) ahead might prove too optimistic, as illustrated by the following quote from a recent report by stockbroker Morgans:
"We see a strong chance of FY19 results beating low expectations, but market estimates for FY20 look too heroic, leaving scope for some disappointment versus very stretched valuations."