Rudi’s View: February Trends, Winners, Signals & Losers

Always an independent thinker, Rudi has not shied away from making big out-of-consensus predictions that proved accurate later on. When Rio Tinto shares surged above $120 he wrote investors should sell. In mid-2008 he warned investors not to hold on to equities in oil producers. In August 2008 he predicted the largest sell-off in commodities stocks was about to follow. In 2009 he suggested Australian banks were an excellent buy. Between 2011 and 2015 Rudi consistently maintained investors were better off avoiding exposure to commodities and to commodities stocks. Post GFC, he dedicated his research to finding All-Weather Performers. See also "All-Weather Performers" on this website, as well as the Special Reports section.

Rudi's View | Mar 08 2023

In this week's Weekly Insights:

-February Trends, Winners, Signals & Losers
-Advice From The Best: Klarman & Buffett
-Research To Download

By Rudi Filapek-Vandyck, Editor

It is often said that investing in the share market, ultimately, comes down to corporate earnings - where earnings go, share prices must follow.

This narrative, however, covers only 50% (at best) of what moves and guides share prices. The other half are forecasts and expectations, which in large part are guided by macroeconomic prospects and events.

The first two months of calendar year 2023 stand out through a marked discrepancy between the two major forces that drive equities and general risk appetite.

On one hand, there's optimism to be had from a resurgent China and the fact most countries seem to have avoided the worst from what looked like an unavoidable energy crisis. On the other hand, companies are clearly struggling with headwinds and slowing momentum, and only a brave soul would call the end of the impact from central bank tightening today.

The macro versus micro divergence has turned February into the proverbial cold shower that brought back some realism into what appeared a lot of exuberance that previously underpinned January's strong rally. February's negative performance was never going to be solely about corporate hits and misses, of course, with global bond markets and evolving inflation forecasts equally making an impact.

But February wasn't great - not when we zoom in on corporate profits, underlying trends and margins; even the most bullish among the bulls might have to concede as much. February has turned into a thorn in the side for all those forecasters who believe the low is in for markets and a new bull market is taking shape.

I am by no means suggesting such predictions are 100% guaranteed to be incorrect, but historically a healthy bull market is supported by both macro and micro forces.

With corporate profit estimates falling prior to and during February, and expected to fall further in the weeks and months ahead, it seems like all the good news needs to come from the macro side, without the micro providing yet another cold shower moment in August or beforehand.

Viewed from this perspective, the next US quarterly results season starting in mid-April and local confession season in May-June might prove more important than usual. In the US, many a profit margin remains high by historical standards and any "normalisation" that is yet to occur can potentially accelerate the pressure on historically elevated valuation multiples.

In Australia, a notable number of companies missed market forecasts with their interim performance while management teams at the helm refused to change full year guidance. As the numbers for FY23 become clear(er) approaching June 30, the big test locally will be whether such companies have to concede or not.

On stockbroker Morgans' data gathering, some 49% of companies are now depending on a second half skew compared with 25% in pre-covid times.

Companies that could be at risk of a profit warning during confession season in Australia include Challenger ((CGF)), Corporate Travel Management ((CTD)), Credit Corp ((CCP)), Domain Holdings Australia ((DHG)), Domino's Pizza ((DMP)), Flight Centre ((FLT)), Healius ((HLS)), Lendlease ((LLC)), Medibank Private ((MPL)), News Corp ((NWS)), Nine Entertainment ((NEC)), REA Group ((REA)), and Sims ((SGM)), analysts at Macquarie have suggested.

A cautious Morgans is looking towards small cap companies as being most at risk.

Results season analyst at PAC Partners, Shane Bannan believes the likes of Accent Group ((AX1)), Breville Group ((BRG)), Nick Scali ((NCK)) and Super Retail ((SUL)) are likely to be "cruising for a bruising" as covid response momentum won't be sustained and valuations look too high for when the slowing in momentum arrives.

Cleanaway Waste Management ((CWY)) and Data3 ((DTL)) are equally overpriced, on Bannan's assessment.

February - The Numbers

Reporting seasons never consist of only winners or losers; every season delivers a mix. Viewed from a positive angle, 90% of Australian companies reporting in February were profitable and after strong growth in dividend payments last year and the year prior, the retreat in total dividends announced last month was really quite minor, considering big payers BHP Group ((BHP)) and Rio Tinto ((RIO)) had to halve their payouts.

All in all, total dividends of circa $47.8bn fell some -$1.4bn short of analysts' estimates prior the February season, Macquarie reports. On Janus Henderson's numbers, total dividends paid out in Australia reached an all-time high in local dollars in 2022 for a total of $97.7bn.

Banks and mining companies were responsible for more than three quarters of that new record, with BHP the world's number one and Rio Tinto the number seven in terms of total dividend paid to shareholders.

In February, compensation came through via oil and gas producers, coal producers and insurance companies, but still, on CommSec's calculations some 20% of companies lowered their dividend in February, including Adbri ((ABC)) whose shareholders for the first time since 2000 will not receive a payout for the six months to December 31.

Twenty percent means one-in-five, which is probably a better indication of how tough the general on-the-ground experiences are for corporate Australia. In aggregate, EPS forecasts for the ASX200 only fell by less than -1% in February, but Macquarie analysts point out estimates have now fallen by -7% on average from their peak in 2022. The first seems benign, the second number suggests significant pressure to the downside.

On FNArena's assessment, more companies (32.5%) missed and disappointed in February than those who beat and surprised positively (29.5%). When put in historical context: it is quite rare to see the larger percentage held by the negative. In all the February results seasons since 2014, this had not happened prior.

The closest February ever was in 2019 when beats and misses equaled out at 33% each. The only August season ever to see misses outnumber beats came along later that same year; 25% misses against 24% beats. With the assistance of Harry Hindsight, we know now back in late 2019, pre-covid, the Australian economy looked genuinely sick.

Two of the Big Four Banks cut their final dividend before all four had to do it in the following year.

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