In the short-term the equity market is a voting machine, in the long-term it’s a weighing machine.
What does that mean? In the short-term anything can drive a share price up and down: in the long-term the true driver of share prices are earnings and dividends.
You’ll find that in between reporting seasons in the USA and Australia the vast bulk of share price movements are driven by macroeconomics and sentiment. During reporting seasons the SOLE driver of share prices are delivered earnings versus expectations and outlook statements.
The good news is over the next two weeks in the USA and Australia we will see some clear earnings and outlook facts. There will be share price volatility, but it will be based on fact rather than suspicion.
The Q1 reporting season is already well underway on Wall St. But this week it really gets going and we will get a very clear picture of the overall state of US corporate earnings.
S&P 500 Earnings
This week is the biggest week of 1Q16 earnings. 36.4% of the S&P market cap (185 companies) will be reporting earnings. On a sector basis, for six of 10 sectors this week is the biggest one this earnings season: 31% of Consumer Discretionary, 31% of Consumer Staples, 61% of Energy, 40% of Health Care, 53% of Materials, and 51% of Telecom will be reporting earnings. Additionally, 28% of Financials, 42% of Industrials, 35% of Technology, and 42% of Utilities will be releasing numbers.
Thirty eight per cent of the S&P market cap has reported earnings as of last Friday after the close. On the EPS side, the surprise ratio remains positively skewed vs history, as 76% of the S&P 500 came in above expectations and only 16% below expectations, compared to the average since 1Q04 of 66%.
Revenue surprise ratio also remains positively skewed with 58% coming in above expectations and 41% below.
Although improved, the amount by which companies in the S&P 500 beat EPS remains below the historical average (4.1% vs 5.1% avg). Sales results have beaten expectations by 10bps. For historical context, during the last eight quarters, we had seen a 60bps beat in sales on average. The S&P 500 Ex-Fins has beaten EPS by 4.6% and beaten sales expectations by 10bps.
However, it must be pointed out that “high expectation” stocks are being hit if they don’t deliver on the markets high expectations. Already we have seen Netflix, Microsoft, Alphabet (Google), Twitter and Apple all fall -7% to 20% after confirming revenues worse than expected. This is interesting because “tech” has led Wall St for many, many years and some parts of tech, particularly Apple, are looking tired because they are growthless. American investors seek growth over value, never forget that. That was why Facebook is up +7% after reporting; it delivered revenue surprise to the upside.
Below is a chart of Apple’s CY16 consensus earnings estimates (red line) vs. the share price in white. On last night’s close the share price has fallen almost exactly the same percentage as the consensus downgrade.
In Australia, over the next three months, next week will be the most important week for the ASX200.
Why will May 2nd to 9th be THE most important week for the ASX 200?
- By market capitalisation almost 50% (47%) of the ASX 200 and 10 of the top 13 market weighted stocks will provide data points – sales / earnings / trading updates / shipments / AGMs / guidance over that six day period.
- Notably, that 47% of market cap figure EXCLUDES all companies presenting at a Macquarie’s “Australia Conference” from May 4 to 6.
- If I include the conference and avoid double counting, that 47% of market cap figure becomes almost 65%.
- Importantly the spectrum of industry covered in those five days, excluding the conference, is very broad – banking (WBC ANZ CBA NAB & MQG); financial services (AMP IRE & GMA); wealth management (BTT); supermarket retailing (WOW); mining (BHP FMG & AWC); real estate (DXS GPT GMG MGR & SCG); media (OML NWS & REA); infrastructure (TCL); contracting / mining services (DOW); and marketing (CTX).
It needs to be remembered that the Macquarie conference has often been used by domestic companies to downgrade expectations. With a Federal election campaign now underway I wouldn’t be surprised to see some Australian companies blame the combination of political uncertainty, the higher AUD, weak consumer confidence and unseasonably warm weather as an excuse to hose down earnings. I’d suspect discretionary retailers are a sector to be cautious on into next week, particularly clothing retailers.
Remember, we’ve already seen Qantas (QAN) blame the election/consumer/business confidence for a reduction in domestic capacity that has seen -20% wiped off their share price. McGrath (MEA) stated that NW Sydney sales volumes were down -30%, while Murray Goulburn (MGC) pointed to the AUD as a reason for a -34% earnings downgrade. The Australian earnings downgrade season has started and I expect it to continue next week.
That is why I am attempting to keep my Australian exposure to rock-solid non-cyclical exposure. I am very much parked in what I consider “earnings and dividend certainty” stocks even though they have underperformed a little recently as resources experience a major short-squeeze positioning rally.
Clearly, in markets like these the share price punishment for the “crime” of downgrading expectations is outsized. We are seeing way more than just the effect of the earnings downgrade wiped off share prices. In the Qantas example the consensus analyst downgrade was -7% and the share price fell 20%, meaning the P/E effectively fell 13%. The chart below demonstrates this and suggests QAN is currently oversold.
QAN FY16 consensus earnings estimates (red line) vs. share price.
While all this earnings news and trading updates are coming out globally and locally we also have news from central banks. The Fed said nothing new last night and bond yields fell to reflect the view the Fed is on hold until later this year. The Bank of Japan comments this afternoon but expectations of news are low there.
What has been most interesting is the Australian economists response to the much weaker than expected Q1 CPI print here yesterday that saw the AUD/USD fall -2% to 76.00usc.
That clearly was a surprise to everyone. You don’t see the AUD move like that unless there is a genuine surprise, and that weak CPI number was a genuine negative surprise. When followed in the afternoon by Westpac confirming they won’t lend to foreign-based property investors, it is understandable why interest rate cut expectations increased sharply in the interest rate futures market.
They are now many forecasters calling for Australian cash rates to drop to 1.50%. I’m not so certain about that but put it this way, the risk of them rising in the short to medium-term is 0% and the risk of them being cut is now around 50%.
What does all this mean for an Australian SMSFs? It firstly means the search for yield will continue. The so called “yield trade” is far from dead: in fact it’s more alive than ever. That is why I’ve been banging away in these notes about assured dividend/distribution growth stocks such as Telstra (TLS), Transurban (TCL) & Sydney Airport (SYD).
What it also means is that the AUD has most likely peaked for the short to medium term and foreign earning industrials and unhedged offshore funds will outperform. I think it’s the perfect scenario to seek income in Australia and growth internationally. Those who attended the recent Switzer Investor Strategy Day seminars would be well versed in my view and portfolio positioning of “Australia for income, international for growth”.
And finally, I hope you’re all sitting down, I believe that there’s a growing chance of a relief rally in battered Australian banks. Clearly short positions are enormous and expectations are pessimistic ahead of results and dividends starting next week. But remember this is what the resource sector looked like in January when my olde mate Peter Switzer was telling you to buy BHP at $15.00.
Personally I think the Australian bank sector is lining up for a “short cover the fact” reporting season and hopes of lower cash rates will help that scenario. Don’t get me wrong, I don’t think you all need to run out and buy more banks, you all own plenty, but there’s a clear chance of a relief rally in Australian banks over the next few weeks.
Either way, there is a plethora of stock specific information over the next two weeks and it will give us all far greater clarity on the state of US and Australian corporate earnings.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
