I think that the earnings pulse has been weak through 2019 and [this weeks] updates relate to that weakness, says Chris Nicol, Morgan Stanleys lead Australian equity strategist. The question is whether the bar is optimistic.
He believes that could be the case for some. Companies especially those exposed to the domestic economy have rallied over the past year, partly because of lower interest rates but also on the expectation the local economy will improve its sluggish pace of growth.
Optimism misplaced
Three interest rate cuts,tax cuts for low- and middle-income earners, and less stringent borrowing requirements are expected to boost the economy, Nicol says.
The signs are optimistic, with house prices rising in the second half of last year and global tensions abating.
Investors started to look again at the companies most exposed to the domestic economy. Consumer electronics group JB Hi-Fi repeatedly hit a record high in the second half of 2019 and the ASX 200 retail sector has risen 41 per cent in the last 12 months, outperforming the wider market, which rallied 18.4 per cent.
But Nicol says there isnt concrete evidence the Australian economy is picking up significantly, with the hope for improvement generated by the mid-2019 stimulus measures tempered by the drought and summer bushfires.
Consensus was hopeful that we would start to turn a corner through Christmas. What we have had instead is a significant setback drought and fires and a dampening of sentiment, he says.
Companies exposed to the domestic economy are at particular risk heading into reporting season. We would be cautious on the consumer discretionary sectors and some of the companies linked to housing market activity, such as retailers and landlords, Nicol says.
We think that investors are underestimating what it means to be in a deleveraging environment. This is the first time that credit growth hasnt responded significantly [to stimulus]. We are seeing a different reaction from consumers.
Randal Jenneke, portfolio manager at T Rowe Price, is also expecting an uninspiring set of results from domestically focused businesses. He says the June-December period was pretty tough for many companies.
Time for miners
Jenneke believes earnings season will be saved by the miners, where share price performance has been relatively subdued over the past year. The ASX mining sector is up just over 12 per cent, underperforming the market.
When I think about the companies that are going to move the needle in terms of earnings, I think that mining companies will probably do very well, he says.
Companies that could report really strong numbers are likely among iron ore miners, including Fortescue Metals Group, BHP and Rio Tinto, Jenneke says.
A solid earnings performance from the miners and a weaker performance from domestically focused companies wouldnt vary much from last year. I dont think the trends are going to change that much this season compared to last season, he says.
Jennekes positive view on the miners leads him to a broadly positive view for reporting season. Earnings growth is going to pick up.
He shrugs off this weeks profit warnings. There are always going to be companies that disappoint one way or another.
Hasan Tevfik, strategist at independent research firm MST Marquee, says technology and healthcare and some consumer staples are priced for an earnings beat this earnings season.
Shares in blood products company CSL surged to more than $300 in January and technology companies have also reached dizzying heights in the last year.
The ASX healthcare sector has rallied 52 per cent the past 12 months, while the technology sector gained 34 per cent.
Investor interest spread to the consumer staples sector, where stability of earnings were rewarded, such as supermarket Woolworths and conglomerate Wesfarmers. The sector has risen 24.3 per cent the past 12 months.
Yield-hungry investors have also been piling into banking giant Commonwealth Bank, the only major bank not to rebase its dividend over the last few years, even as expectations for the sector remain weak.
It should be possible for companies to meet or beat consensus, given that earnings expectations are comparatively low for this year and next.
Earnings expectations are not especially elevated. Its not a particularly high bar that companies have to pass, says Fidelity International investment specialist Anthony Doyle.
Jason Teh, chief investment officer at Vertium Asset Management, says: As long as you punch out numbers consistent to expectations (then share prices will be supported).
However, the bar gets higher as valuations go up, he adds. If the starting point is high expectations from high multiples, then the ability to deliver becomes less.
How much do you pay for safety? Woolworths is not that bulletproof. Its not a gas pipeline operator, for example, Teh says.
Doyle at Fidelity adds after a strong [sharemarket) rally, its going to be a stock-specific story. Some could struggle in the short term. We saw that with Treasury.
Like any reporting season, one of the most crucial factors for share price performance will be how companies view the future.
The more important focus is going to be what the companies say about their outlook, says Jenneke.
Outlook statements, momentum and corporate animal spirits will be very important, agrees Nicol. Whats the tone going to be?