Australian markets strategist, Saxo Bank
The Aussie benchmark index has outperformed other global markets year-to-date, benefiting from a weaker AUD (down around 5% against USD since January 1) and outflows from the APAC region amidst trade tension volatility given that the ASX is relatively inward-looking and domestically focused.
The ASX is inching towards its 2007 highs, and has reclaimed its 10-year high but has yet to reclaim the 2007 peak of 6,828.71.
The healthcare index has been the year's clear outperformer followed closely by the energy sector, while financials and telecoms have struggled. The ASX has been rangebound for the past month with the index unable to sustain the 6,300 level; without strong earnings momentum we are unlikely to see a sustained breakout.
With earnings season having kicked off last week we are expecting a robust but restrained season with analysts expecting EPS growth of around 8% down from 11% in FY17. Domestic economic conditions, with stable unemployment and low interest rates, have been supportive for corporate Australia but not stellar.
Current valuations limit upside potential and without very strong earnings momentum we are unlikely to see a sustained breakout on the ASX 200 index. Analyst consensus shows us that most companies are expected to meet guidance with the exception of telecommunications firms.
Upside surprises are likely to come from companies that benefit from the weaker AUD, supportive commodity prices, and US-led growth.
Key themes to watch
1. Banks are facing numerous headwinds as both revenue and expense trends are weaker. Higher wholesale funding costs as US interest rates rise, heightened regulation, and a slowing credit market (with the slide in house prices set to continue) will all put pressure on net interest margins and profits. The forward outlook is likely to be challenging as regulatory costs are likely to increase and the housing market continues to slow. The differentiating factor in forward outlooks for the big banks is likely to be the cost-cutting and restructuring plans that will reduce expenses moving forward. Commonwealth Bank is expected to report its first drop in annual profit in nine years.
2. Growth stocks have outperformed value stocks so far this year and stretched valuations set the bar high. As we have seen in the US with Facebook and Netflix, there is very little margin for error and growth stocks are priced to perfection so the onus to deliver is strong. For companies like Domino's, Cochlear, Bellamys, Afterpay, REA Group, Treasury Wine, Wisetech, and NextDC, if earnings miss expectations we could see sharp falls in the share prices.
The interesting thing here will be whether high PE stocks will continue to be rewarded or whether we will start to see a rotation towards the long-overlooked value stocks. In this event, we could see this rotation continue towards the end of the year. However, caution must be exercised here as this rotation has had many false starts and value stocks have significantly underperformed growth stocks for the past 10 years.
3. The current resources cycle has been supportive for miners and energy stocks with WTI crude oil up 15% ytd. Commodity prices have been supportive for miners like BHP and RIO and these stocks offer upside from buybacks and dividends. BHP have finalised the sale of its US shale assets to BP and management have been very vocal with respect to returning the proceeds to shareholders. A large buyback would increase EPS by 5-10%. Rising oil prices are likely to feature as a cost inflation headwind for miners throughout reporting season.
4. The US has been a clear outperformer on the global macro stage in terms of growth and record low unemployment. The fiscal stimulus has the US economy running on a sugar high and this, along with the currency exposure, is likely to present positive tailwinds for ASX stocks with US exposure. These include Aristocrat, Ansell, Resmed, Boral, Corporate Travel Management, Orora, and WorleyParsons.
5. We saw a boost in retail spending in June and strong consumer confidence which could buoy earnings for specialty retailers like Adairs and Noni B – especially as Amazon's arrival is unlikely to have had a real impact yet. However, given the slump in home prices and rising competition we are relatively cautious in the retail sector. Risk is likely to be centred around consumer discretionary stocks like Coca Cola, Domino's Pizza, and Harvey Norman.
6. In the infrastructure sector, federal and state government investments as well as growing demand for infrastructure in large cities should provide structural growth for companies like Wagner’s, Boral, and Transurban. Cleanaway waste management also looks set for an earnings beat or upgraded outlook as its Toxfree acquisition contributes to future growth.
7. The Aussie market is a high dividend-yielding developed market, so as always dividends will be in focus for investors; 69% of companies that reported in February had increased dividends. This quarter, according to Bloomberg data, five times as many as many companies are likely to increase dividends from a year earlier.
The Labour Party’s proposals to abolish concessions that allow dividend imputation credits to be refunded may encourage companies with hefty franking accounts to fast track capital management initiatives such as paying special dividends.