The recent reporting season has delivered a mixed outlook for the Australian market, with strong stock gains overshadowed by emerging weaknesses in underlying fundamentals, according to Reece Birtles, chief investment officer at Martin Currie.
Despite positive early results and a rally in momentum stocks, Birtles has highlighted that ongoing earnings downgrades and recent market volatility signal potential risks ahead.
“Actual results were quite similar to the last three reporting seasons back to February 2023. They were softish, but they weren’t weak like 2019,” Birtles said in a recent webinar.
Approximately 40 per cent of companies reported results largely in line with expectations, while 33 per cent delivered positive surprises, with discretionary retailers, banks, and tech stocks emerging as the strongest performers relative to forecasts.
Although initial results seem positive, a closer analysis reveals a trend of downgraded earnings forecasts for the next 12 months, largely due to weak guidance from company management.
Namely, over 40 per cent of companies in sectors such as resources, energy, housing, and discretionary services have experienced downgraded earnings forecasts, while only 25 per cent have reported upgrades. Meanwhile, about 32 per cent have seen no change in their forecasts.
“The slowing inflation environment is leading to a slowing revenue environment, and for the first time since August 2020, we actually had a downgrade to revenues. That’s putting a lot more pressure on companies in terms of maintaining earnings forecasts,” Birtles said.
As a result, markets should likely prepare for a revenue growth environment of around 2 per cent moving forward.
Putting the revisions in context, Birtles noted the overall breadth of earnings revisions was not alarming, although the average revision for companies was nearly -3 per cent, the worst recorded since 2019.
Additionally, the ASX 200 index aggregate earning per share (EPS) revision also stood at around -3 per cent, the worst in the last decade during a reporting season.
“That is, in part, driven by large caps like the miners with commodity price downgrades – but it is a signal of where we are in the cycle,” Birtles said.
Appeal of momentum stocks
The markets are currently in a “Goldilocks” environment, the CIO explained, characterised by strong share prices, robust earnings, high price-to-earnings ratios, and generally positive returns across most sectors.
This is in contrast to macroeconomic indicators like purchasing manager indices (PMI), which suggest modest levels of activity.
“All those things generally suggest that EPS for companies would be quite negative,” he said.
“On a global basis, EPS has been reasonably positive still, certainly since the AI hype has helped a lot of the large caps in the US, but in Australia, we are seeing those earnings trends reflect the weaker PMI or economic environment.”
Expanding on the need for caution, he outlined interest rates remain restrictive, adding to concerns around economic growth.
Birtles noted that standout performers in the last reporting season were stocks with momentum characteristics, as markets favoured those with strong recent performance and prior earnings revisions, while stocks benefiting from falling bond yields and inflation also performed notably well.
“This market reaction, in terms of how stocks are behaving, is still very much in the Goldilocks scenario, despite what you might see when you’re looking at things like economic conditions and earnings revisions fundamentally from companies,” he said.
Valuation spreads between cheap and expensive stocks have reached extremes, as previously seen in three other “anomalies” in the last 25 years, namely the tech bubble of the early 2000s, the Global Financial Crisis of 2008–09, and the COVID-19 pandemic in 2020.
“We’re approaching those COVID extremes in terms of spreads,” Birtles said.
“It’s a very unusual environment where the price paid for those high momentum stocks is at extremes.”
