Last month we discussed the impact of geopolitical tensions on domestic and global growth and in turn on company earnings. This month we saw the evidence in black and white with the release of our quarterly national accounts and the release of full year results for most of our major companies.
Our economy grew at 0.5% for the June quarter according to the Australian Bureau of Statistics quarterly national accounts data released on September 4th. This was the weakest growth rate since the Global Financial Crisis (GFC) over a decade ago. Reporting season mirrored the broader economy and provided further confirmation that business conditions and earnings across most sectors deteriorated year on year. We appear stuck in a cycle where slowing growth is leading to further cuts in interest rates by central banks which is turn is driving asset prices and markets higher. This reporting season the disconnect between company earnings and company valuations increased. So too have the risks.
For the ASX top 200 stocks, 138 reported full year earnings to June during July and August with 31 reporting half year or interim results. The remaining companies for the most part have balance dates other than June or December including 3 or our 4 major banks.
Just over half of companies were able to lift profits and dividends year on year, below long-term averages. Earnings guidance where provided for 2020 was also disappointing with negative earnings revisions for more than half of the top 100 companies.
One of the key take outs from reporting season was the divergence in the performance of the two largest sectors on our stock market – banking and resources. The banks account for about 25% of our market and resources about 15%. The strength of our resources sector and particularly the iron ore exposed majors (BHP, RIO, FMG) has been a key theme in recent economic updates. As expected, it was the standout of reporting season. The three majors all delivered excellent operational performances which translated into huge cash flows and dividend increases. Iron ore prices remain above trend due to specific supply disruptions in Brazil but low levels of capital expenditure since the GFC generally has reduced volume growth and this along with productivity increases is supporting prices and lifting margins. Dare we say that resources are now looking like the most prospective yield plays in the short to medium term. Conversely, the banking sector is under pressure. CBA is the only top four bank with a June balance date but along with the second-tier banks and a quarterly update from NAB the factors impacting performance and earnings are sector wide and the results and narrative for the other banks are expected to mirror the CBAs. Low credit growth, increasing competition from non-bank lenders, interest rates now at levels so low that margins are compressing, remediation costs post the royal commission and signs that historically low levels of impairments are trending upwards are all making life for banks the toughest we have seen in decades. Market consensus is for flat earnings and dividends in the short to medium term and the possibility of lower dividend yields cannot be ruled out.
Aside from the banks companies exposed to global trade tensions, the building sector and the consumer delivered some of the poorest results. Boral which we hold produced one of the most disappointing results along with Adelaide Brighton. Delays in the ramp up of major infrastructure projects, declining dwelling construction and rising input costs were contributing factors.
Other strong performers along with resources at the sector level were Health Care and Information Technology (IT). Healthcare is a sector we like for both its growth and defensive qualities. It is also a sector where Australia continues to punch above its weight producing global champions across medical devices, hospitals, pathology and biotechnology. CSL our largest healthcare stock was again the standout delivering double digit revenue and earnings growth in its blood products division and even higher growth in its vaccine division. ResMed which is the largest holding in our portfolio also delivered an excellent result. Information Technology, a small but rapidly rising sector in our market was another standout. Again, Australia is producing a number of global champions in this space many with the competitive advantages and other characteristics consistent with our investment philosophy and approach. Wistech, (global logistics software), Altium (electronics software design) and Appen(Artificial Intelligence software) all delivered excellent results.
The issue with a number of the high growth stocks we like is valuations. Many sectors and stocks are now trading well above fair value. In the Information Technology space software companies are now trading at eye watering multiples in the USA and in Australia. Valuations also look stretched for many of the growth stocks we rate in the Health care space including some we own such as CSL and ResMed. Should the valuation multiples for these stocks trend much higher we will look to take some profits. Growth stocks generally have been bid up to unrealistic levels. Many defensive stocks with growth above GDP and a steady dividend yield are also trading at historically high multiples and in the case of property trusts at levels well above their underlying asset values. There are pockets of value, but they are getting harder to find. Resources in our view is one of the few sectors trading at or below fair value.
Falling interest rates and the lower for longer mantra are key
factors supporting and driving higher valuations in risk assets. (i.e. property
and shares) The sharp slowdown in economic growth in the June quarter is again
raising expectations the Reserve Bank of Australia will lower rates further after
leaving the cash rate on hold this month at 1%. Our own view is that monetary
policy is now moving from less effective to counterproductive and the distortions
it is causing in asset prices is adding more systemic risk. The apparent
rebound in property prices on the back of lower interest rates in Sydney and
Melbourne is a case in point. We will
continue to position the portfolio defensively with relatively high levels of
cash and remain patient until value returns to the market.
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Sources: Commbank Global Markets Research, RBA, Morningstar.