Status Quo
By Rudi Filapek-Vandyck
Two important factors continue to act as a dampener on overall investor enthusiasm:
1.) Economic growth will slow down from its current liquidity and stimulus boosted levels, but when exactly and to what extent remains open for public debate
2.) The current rebound in economic strength will push more and more central bankers into tightening mode, but, again, when exactly and to what extent keeps market views highly divide.
According to the more positive market views, economic growth in major economies (China, US) will weaken in the second half of this year, but still remain at elevated levels. Consumers won't be participating at full force, but they won't have to as yet with business investments, re-stockings and expansions taking up the slack for the remainder of this year.
If inflation remains low, as many experts believe it will, then central bankers in key countries should be in no hurry to get aggressive (China) or to start tightening at all (US), which should allow risk assets to continue climbing the wall of worry throughout 2010 and into 2011.
Those with a less positive view doubt whether such a positive scenario can go on for so long without a substantial participation of consumers in large economies of the US and Europe.
Thus far, the pendulum has firmly swung in favour of the optimists. This has allowed commodities to rise to near 19 month highs, while equities indices across the globe equally are at or near 19 month highs.
Meanwhile in the US, corporate results on balance manage to beat already high market expectations, while economic data and indicators continue to push up growth forecasts for this year and next. And China hasn't raised interest rates and might not do so for a while yet.
Quite ironic really that amidst all these ongoing positives, both commodities and equities have run into stiff resistance towards the end of April due to investor concerns that prices might have run up too high too soon.
It is difficult to put a fair value on the price of crude oil or copper, but when it comes to the share market, earnings expectations serve as the ultimate guide for investors, especially since we left the "dash for trash" behind in late 2009. From here on the share market's ultimate fortune will be determined by the outlook for corporate profits.
Alas, the news on the corporate earnings front in Australia has become a lot less buoyant in April. Until early this month the positive impact from continuous upgrades to earnings forecasts served as a powerful stimulus behind ongoing share market gains. Over the past two weeks, however, this picture has somewhat changed with further increases rather benign and with analysts starting to cut some of their earlier forecasts.
As a result, projected growth forecasts as implied by consensus estimates haven't changed over the past four weeks. This would suggest that while upgrades to forecasts have continued outnumbering downgrades, the latter have nevertheless managed to negate any net gains overall.
Current consensus forecasts still anticipate Australian companies will improve their earnings for shareholders by between 5-6% in fiscal 2010, followed by a jump of close to 20% in fiscal 2011.
So who's responsible for the status quo in earnings expectations this month?
My first reflex would be to point the finger in the direction of defensive sectors such as telecommunication, consumer staples and health care. Smaller telcos such as iiNet ((IIN)) might still enjoy positive momentum from ongoing earnings upgrades, for the bigger players in the sector Telstra ((TLS)), SingTel ((SGT)) and Telecom New Zealand ((TEL)) the opposite holds true.
Telstra's short term fortunes might seem closely linked to the outcome of NBN-negotiations with the Australian government, in the background of today's headline stories and commentaries, securities analysts have been steadily downgrading their forecasts. On current estimates Telstra's growth will be negative this fiscal year, and barely positive in FY11.
The trend is not nearly as bad for SingTel, who owns Optus in Australia (and is reportedly looking for a demerger), but for Telecom NZ the trend is much, much worse. On current market expectations, Telecom NZ's earnings per share will continue to decline for at least the next two years. If these projections prove correct, the company's EPS will have halved between 2009 and 2011 (minus 50%).
Consumer staples stocks have similarly enjoyed reduced profit expectations this month, with question marks hanging over future margins and growth potential for both Woolworths ((WOW)) and Wesfarmers ((WES)). Earlier in the month similar questions had emerged for consumer discretionary stocks, as foreign competitors are now increasingly looking to enter the Australian market and with higher interest rates expected to put a lid on future consumer spending.
The biggest shifts, however, have occurred in the health care sector with companies such as Primary Healthcare ((PRY)) and Sigma Pharmaceuticals ((SIP)) recording large reductions in earnings forecasts.
In comparison with the earlier mentioned stocks in telecommunication and consumer staples, most healthcare stocks, including Primary, are still expected to grow EPS by significantly larger numbers in the years ahead. The problem is, however, most healthcare stocks tend to trade on high multiples. This is why the effect on share prices has been quite severe as both forecasts and multiples have contracted at the same time.
Probably the best illustration of this was this week's sell-off in CSL ((CSL)) shares. Prior to competitor Baxter's rather subdued assessment for the US market outlook for blood plasma, the shares were trading on a FY10 Price-Earnings ratio of 20. Post Baxter's industry outlook, the multiple has fallen to close to 17.
While this may not seem like much, shareholders have seen more than 10% being wiped off the value of their CSL shares in the process. To make matters worse, CSL is now expected to improve its EPS by 11% this year and by 7.6% only next year. Surely, the main question hanging over this stock for the months ahead is whether this outlook is correct and if so, does such an outlook deserve high multiples from the past?
I wish I could state, like market analysts elsewhere in Asia, that all these sectors have been holding back further progress in earnings support this month in Australia, but unfortunately, there have been many more culprits.
On top of the list sit many resources companies whose March quarter production reports either fell short of market expectations, or otherwise failed to inspire stockbroking analysts to further increase their estimates. Most large cap resources companies, however, simply disappointed this month, including Lihir ((LGL)), Newcrest ((NCM)), BHP Billiton ((BHP)), Rio Tinto ((RIO)), Santos ((STO)) and Woodside Petroleum ((WPL)).
Without exception, all production reports by these companies triggered cuts to forecasts this month. Luckily, for management and for shareholders, market expectations remain for higher commodity prices later this year and next, supporting much higher target prices, (mostly) positive ratings and ongoing expectations for further upside potential.
In addition, many industrial stocks have seen market expectations take a step back these past weeks, including Gunns ((GNS)), Graincorp ((GNC)), Hastie Group ((HST)) and the Australian banks. The latter are about to report interim results or update their shareholders otherwise on operational results in the coming weeks so it will be interesting to see whether this trend will be reversed.
If not, the Australian share market might find it difficult to move much higher beyond 5000 as the term "fairly valued" is increasingly appearing in stockbroker research reports, and increasingly as motivation behind recommendation downgrades.
Investors should note, on current FY11 consensus forecasts, the Australian share market could rise as high as 5200 before the market would become "fully valued" in a general sense. This broad assessment is based upon a multiple of 14.5 applied to present average FY11 consensus forecast for the ASX200. This does not take into account that recent price adjustments for bulk commodities have made the likes of BHP Billiton and Rio Tinto look ridiculously cheap on FY11 metrics.
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