As at 21 Feb, 63% of the total market cap of the ASX had reported earnings, the median beating their net profit forecasts by 0.8%. Of every 7 companies that have reported, 4 have exceeded market expectations and 3 have not. This is a pleasant surprise given that the Omicron variant ripped through the country in recent months causing many to bunker at home. Domestic consumer-exposed stocks are due to report this week which may be a little more somber and reflect better the COVID-19 impacts.
The net result so far for reporting is that earnings expectations for the full financial year 2022 have been upgraded 0.5%. Energy and financials have been the primary driver of the upgraded expectations.
With the recent pullback of the ASX on the back of rising interest rates and potential conflict in Russia, the total market price to earnings ratio sits at 16.6x– a discount to the 5-year average.
Overnight, the S&P 500 broke under the January 2022 low entering bear market territory. The ASX200 is yet to test the January low, but this may be the catalyst needed to force its hand.
Despite the obvious negative sentiment, ~45% of the ASX200 market capitalisation is exposed to sectors that look to be enjoying economic tailwinds, pointing to a potential rally into the end of calendar year 2022 and a buying opportunity through to the June.
Commodity Super Cycle 2.0?
Demand for commodities globally remains robust and is pushing prices higher, further exacerbated by concerns about supply shocks from the Russia/Ukrainian conflict. Inflationary environments are also conducive to higher commodity prices. Unlike 2008 when the last commodity boom occurred, the Australian dollar has not responded to the lift in commodity prices.
I surmise that the reason the AUD has lagged commodities is the expectation that the US will lift rates faster than the RBA. Also, the USD becomes a haven in times of conflict.
Why must the RBA be cautious on rates?
Australia’s debt to income ratio is comparatively high, and the RBA is cognizant that being too aggressive with interest rates could easily push the economy into a recession, a situation they will work very hard to avoid.
Additionally, a quasi-natural rate hiking is expected to occur in 2023 when >$350b of fixed rate loans roll off and are refinanced at ~4% vs ~2.5%. The RBA’s term funding facility (which was created to help provide banks with liquidity during COVID-19) also rolls off in 23-24 which will need to be replaced by the banking sector with higher wholesale funding. This pricing differential is expected to be passed through to borrowers.
Currently the market is pricing 2-2.5% at peak however this could be too bullish. A 1-1.25% terminal rate is more likely. This wouldn’t be the first time the market has been too bullish with rate hikes both here and in the US.
Higher prices coupled with a range bound AUD is highly positive for Australian commodity producer’s earnings. 28.6% of the ASX200 is populated by energy and mining/materials companies, so owning the ASX200 means a reasonable exposure to this cycle should it come to fruition.
As for the banks, while it looks prima facie that conditions could be improving for their margins, in terms of historical mean valuations they don’t appear to be cheap… yet.
Notably, the Australian stock market has finished the year down 10% only 5 times since 1980, for the S&P500 that number is only 3.
Notwithstanding that caution should remain, it is not very often that we are presented with the opportunity to buy quality companies at relative discounts and although it is unlikely to pick the absolute bottom, it would be remiss not to take this opportunity to buy quality companies for the long-term.