The outcome of the reporting season (currently underway at time of writing) will provide useful indicators for investors on how the Australian market is tracking and where opportunities lie for the next 12 to 18 months.
So far, the delivery of fiscal 2010 results has largely remained within guidance and expectations. But the accompanying cautious guidance for the next financial year seems to be a standard feature of the reporting season thus far. The remainder of 2010 appears to offer challenging operating conditions with expectations of an improvement in the new year.
Some comments on a few of the results so far include:
Commonwealth Bank saw negative half-on-half revenue momentum as loan volumes remained subdued and margins came under pressure from higher funding costs. Rising operating costs were offset by lower bad debt provisioning. Out of cycle repricing of home loans in fiscal 2011appears inevitable for banks to prevent margin erosion, and overall, Australian banks will have to run hard to stand still this half.
- Computershare shocked the market with an outlook for a five to ten percent fall in earnings for next financial year. Corporate actions around the world have come to a grinding halt, reflecting the nervousness of the Boards to sign off on mergers and acquisitions and weak investor appetite for new floats.
- Telstra has finally decided to focus on its market share bleed and its guidance for next year included a high single digit fall in profits in order to fund initiatives to stem its loss of customers. Forecast dividend yield, which is now in double digits, reflects the market’s scepticism on whether the telecom giant may be able to hold its dividend payment next year.
- JB Hi-Fi delivered fiscal 2010 profit in the middle of its guidance range and forecast a sales level that was slightly below market expectations. Much of the result was in the share price which rallied after the announcement.
Overall, there is consensus amongst executives that the Reserve Bank of Australia’s (RBA) heavy foot on the brake early this year, the Resources Super Profit Tax, change in leadership and now the elections, created enough uncertainty amongst consumers and businesses to stay put, keep an eye on their finances, and wait to see what happens. As these headwinds dissipate in the coming months, activity level should pick up leading into Christmas and early 2011.
So, with the recovery phase clearly over, we have now entered a consolidation phase that could last for a number of years. But investors shouldn’t view this as a bad sign. It’s not out of the ordinary for the market to be stuck in a trading band for this length of time, and it is fairly typical for equity markets to consolidate over a period of time when they recover off their bear market lows.
At Platypus, we believe that the market should start to move cautiously upwards again in the December quarter as there is good valuation support here. However this upwards movement will remain muted as long as there is uncertainty about global markets and economies. While reporting season is always helpful in providing a great deal of bottom-up information, a combination of good macro data and a strong reporting season will be needed to break out of the range, and this is likely to be some way off.
Overall, investor sentiment remains subdued as the economic signs indicate a softening in the global recovery.
Australian consumer spending has been underperforming for a number of reasons but predominantly the aggressive rate hikes from the RBA. Although employment is strong, incomes are growing and house prices remain firm, this is not showing in retailers’ tills. With the consumer price index behaving itself in the June quarter and distinct possibility of an out–of-cycle rate hike from the banks after the election, we are expecting that the RBA will keep rates on hold for 2010. The stars are lining for the consumer to make a comeback in the fourth quarter of calendar 2010.
Without a doubt, the sovereign debt problem in Europe posed a real threat to global markets and caused a level of atrophy that is contributing to the current soft patch globally. However, credit markets are normalising and the most recent data from Europe has been strong; in particular, Germany’s export numbers are good and employment and confidence are high. Six weeks ago, Europe looked like a complete disaster but it has astonished most market watchers on the upside.
Unfortunately, the US is looking less convincing. The Federal Reserve is starting to talk about loosening monetary policy further if the current soft patch continues and implemented a symbolic policy of maintaining the size of its balance sheet which, if the recovery was entrenched, should have seen a contraction towards the pre-crisis levels. At Platypus, we think it is likely there will be some more soft data and we will see this policy put into practice more aggressively, with another round of quantitative easing becoming likely.
Most Asian economies continue to perform strongly. The tightening of monetary policy in China seems to be coming to an end although in other countries, including India and Korea, tighter monetary controls are continuing. China recently suggested to banks that they stress-test their portfolios for a 60 percent drop in houses prices in certain cities, which spooked the market somewhat. We see this and other steps taken by the Chinese regulators to keep their banks in check as a positive. One can only speculate that we could have avoided a lot of the malaise from the global financial crisis had the US Federal Reserve been as vigilant about the US financial system in the early to mid 2000s.
Indeed, it is encouraging to see the Chinese government being prudent and watchful rather than sticking its head in the sand vis-à-vis housing issues and valuations, and what these mean for the banking system. We think that the Chinese economy looks strong and, with the monetary tightening at an end, the handbrakes will be off. For Australia, this could mean that further gains in the mining sector are in the pipeline, as China’s economy picks up.
For investors who can overcome their doubts and fears, there are attractive buying opportunities in equity markets. As the world navigates its way through the current soft patch, equities are currently cheap which should limit any downside, while providing an attractive entry point into good quality stocks with strong balance sheets that can survive even if the operating environment worsens significantly. The key elements for investors to look for in any company are: excellent management; consistent performance; and strong growth outlook. Such companies are very well-placed to deliver outperformance, and emerge stronger than ever from the other side when the economy fully recovers.
For example, we are currently overweight in the healthcare sector, and ResMed is the second largest stock in our portfolio. We also hold a number of high quality consumer discretionary stocks, in particular JB Hi-Fi and David Jones which we expect will perform well in the current fiscal year.
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* Prasad Patkar is portfolio manager at Platypus Asset Management, an Australian equities joint venture partner of Australian Unity Investments
