Beyond February: Sorry, no bull

A healthy bull market for equities has both macro and micro feeding optimism and upside. Alas, February has not delivered the required unity

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 Data#3 ((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.

One stand-out observation this year is that investors were much less prepared to grant companies the benefit of the doubt, which also has been one major contributor to February's negative performance. Simply reporting in line and sticking with prior guidance still caused share prices to retreat slightly, according to Morgan Stanley's data analysis.

The strong rally off the October lows required companies to outperform forecasts, but those who managed to do it were only rewarded with an average share price gain of 2%. Those who missed, on the other hand, got punished on average by close to -10%.

Most market analysts have now pared back average EPS growth for this year (FY23), as well as the two following years, below Australia's long-term average of 5.5%, but at face value numbers are dependent on forecasts for the ever so volatile miners and energy companies.

Regardless, an oft repeated factor among those with a more cautious outlook is that EPS forecasts in Australia, as well as in the USA, most likely remain in a downtrend for longer, which makes it difficult to see a fresh, sustained bull market for equities on the horizon.

Another stand-out observation from February is that large cap companies are performing (much) better than their smaller cap competitors. One need not look any further than the 44 ASX50 reporters in February of whom nearly 41% surprised positively and only 29.5% fell short.

For the 159 reporters from the ASX200 (also including those 44) the numbers are respectively 28.3% beats and 33.3% misses.

Sectors Defying Cautious Forecasts

Two market segments defied negative forecasts in February: consumer-spending oriented companies, led by discretionary retailers, and real estate investment trusts (AREITs).

Property values have held up even in the face of aggressive tightening by the RBA and central bank peers globally, and analysts are not quite sure what to make of it. Many a REIT is carrying a lot of debt, so there's a growing headwind through servicing this debt, while new financing facilities are becoming more costly too.

Sector pressures are expected to remain negative for owners of office buildings while consumer spending, or its outlook, keeps a question mark over others.

Citi's team of property sector analysts believe companies and trusts able to grow income will enjoy valuation support. They prefer Goodman Group ((GMG)), Region Group ((RGN)), Charter Hall Retail REIT ((CQR)) and Abacus Property Group ((ABP)).

Macquarie's preferences among AREITs include Dexus ((DXS)), GPT Group ((GPT)), Goodman Group, Arena REIT ((ARF)), HomeCo Daily Needs REIT ((HDN)), Dexus Industria REIT ((DXI)) and Qualitas ((QAL)).

Retailers and consumer companies performed each way in February, also illustrated by the fact that GUD Holdings ((GUD)), Flight Centre ((FLT)) and Eagers Automotive ((APE)) were among the month's best performers on the ASX, while Domino's Pizza ((DMP)), Temple & Webster ((TPW)) and City Chic Collective ((CCX)) were among the worst performers.

Recent analysis by ANZ Bank economists suggests Australian households are not so much reducing their spending as they are redirecting it between discretionary categories. Entertainment and travel are "hot" while non-food retail is weak, and weakening. In line with most forecasts out there, ANZ Bank economists are still bracing for "material impact" from RBA tightening later in the year.

The fixed rate mortgage roll-off everybody has been talking about for more than a year will only genuinely start rolling off from April onwards.

Meanwhile, research by Roy Morgan suggests an estimated 1.19 million mortgage holders, circa 24.9%, were at risk of mortgage stress in the final three months of last year. That number is the highest for over a decade since June 2012 and is now significantly above the long-term average of 22.8% stretching back to early 2007.

On Roy Morgan's data, the number of mortgages at risk increased by 486,000 in 2022. The number of mortgage holders considered 'Extremely At Risk' increased to 710,00 in the three months to January, above Australia's long-term average of 659,000.

February Winners

Stockbroker Morgans has selected CSL ((CSL)), Endeavour Group ((EDV)), Lovisa Holdings ((LOV)), Qantas Airways ((QAN)), QBE Insurance ((QBE)), Tourism Holdings ((THL)), Ventia Services ((VNT)), and Wesfarmers ((WES)) as its Best Ideas from the reporting season just past.

PAC Partners' Bannan has selected Ive Group ((IGL)), Shine Justice ((SHJ)), Codan ((CDA)) and SG Fleet ((SGF)).

Macquarie analysts report sector winners are insurers, staples retail and packaging; all are defensive sectors in which the broker's portfolio has an Overweight allocation. The worst sectors in reporting season turned out to be energy, consumer services, media and capital goods.

Not one single company in each of the latter four baskets enjoyed material EPS upgrades, reports Macquarie.

Morgan Stanley's Model Portfolio was hit hard during the month through a free-falling Domino's Pizza share price, but the stock has remained included as at today. Its quant team confirms High Quality stocks are now outperforming their low quality brethren on the ASX for a third month in succession.

FNArena provides proprietary tools and insights for self-managing and self-researching investors. The service can be trialed for free at (VIEW LINK)

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