Reporting season: the good, the bad and the myeh
August is when the northern hemisphere fund managers and traders take advantage of the summer weather and bundle their families off to the beach. Consequently markets tend to be pretty quiet and this year was no exception. Not a lot happened in Europe and the US and after an extraordinary July the Australian market focused on the full year results season, which was ok without being great.
The bottom line is the Australian market’s June half earnings went down by 6% compared with last year. Last year it was the resources companies that disappointed but this year it was the banks and some of the industrials. Goldman Sachs pointed out that less than 20% of companies beat analyst expectations, whereas it’s usually more like 35%. So why didn’t the share market drop like a stone? A combination of those expectations already being baked in and the market looking forward to a potential pick up in earnings.
So while reported earnings were down it was only about 1% less than had been forecast. How uncannily accurate you might say. What always happens though is analysts start out way too optimistic and then gradually reduce their earnings forecasts by an average of 15% over the two years to when they’re actually reported – see the chart below.
Analysts almost always downgrade earnings forecasts over time
Meanwhile Deutsche Bank actually upgraded earnings forecasts for 52% of companies, which was the highest for at least five years and well above the long-term average of 43%, which is supportive for share prices. In fact, Deutsche Bank pointed out recently that global earnings revisions have turned positive for the first time in four years – see the chart below.
Global earnings revisions have turned positive
Source: Deutsche Bank
What did the earnings season tell us about how Australia’s economy is going? Consumer spending appears to be slowing down: across the results of nine consumer companies like JB Hifi, Crown Casino and Shopping Centre Group (the old Westfield) the growth in spending dropped from 6.2% in the December half to 5% in the June half. Given consumption spending accounts for about 60% of Australia’s GDP, that’s something to watch.
Also, business investment outside of the mining sector is still slowing down. That’s a bit of a concern: since the start of this interest rate easing cycle we’ve seen cash rates fall by 2.75% and yet consumption spending has fallen about 1% and business investment by almost 6%. That’s not supposed to be how it works – like many things in this unusual monetary policy environment.
One reflection of the lower business investment in Australia is the still very high dividend yield on our market, which is about 4.7%, compared with the long run average of 4.5%. If businesses are paying higher dividends it means they’re not using the money to invest in expanding their business, like building new factories. Over the last five years the proportion of profits Australian companies are paying out as dividends has risen to close to 80% versus a long run average of about 65% – see the chart below. There are a couple of reasons for this: first, investors are hunting for yield and companies fear disappointing shareholders and second, if consumer spending is going down, there’s not much incentive to expand your business. Neither reason is particularly cheery.
ASX100 dividend payout ratio and market dividend yield
Source: IBES, Datastream, Deutsche Bank
What’s a central banker gotta do?
Nobody likes it when a plan backfires. You can rest assured one of the main reasons the Reserve Bank of Australia lowered its cash rate on 3 August by 0.25% to 1.5% was to take some pressure off the stubbornly high A$. Alas, in the week following the cut instead of going down the Lil’ Aussie Battler actually went up, despite the RBA hinting it is more likely to cut rates again than increase them.
Our Kiwi cousins had a similar outcome with their rate cut on 11 August, with the NZ$ also strengthening. And spare a thought for the Bank of Japan, which has thrown everything but the proverbial kitchen sink at its currency only to see it strengthen by about 20% against the US$ since the end of last year.
So what’s the big deal? In a world where growth is really hard to come by governments and central banks will go to great lengths to support their domestic economy and a weaker currency makes your exports more attractive to foreign buyers. For instance, Australian GDP growth in the first quarter of 2016 was about 3% and around two-thirds of that came from net exports. The relationship between a weaker currency and stronger export growth is graphically illustrated by the chart below which shows the effect the higher Yen has on Japanese exports.
A stronger currency can impact export growth
Source: Deutsche Bank
How do you weaken your currency? Normally you cut your interest rates so the difference in return between your currency and another country’s is reduced. Alternatively, if your economy is looking like it’s going to weaken then there’s less incentive for foreigners to buy your currency.
Why isn’t it working now? There’s a multitude of reasons for that, any of which might be right. In Australia’s case, at a measly 1.5% we still have higher interest rates than many other countries and our economy is growing at a higher rate. Similarly with New Zealand, where economic growth has been very resilient. In Japan’s case, who knows? Over the period the Yen has strengthened the Japanese share market has fallen, so it’s not foreigners buying Yen to fund stock purchases. With government debt at well more than double its GDP you’d have thought the currency would weaken. Most likely, it’s the perception of being a big, liquid, safe haven market.
The A$, NZ$ and Yen vs. the US$ over the past 12 months
Then there’s the other side of the equation: for one currency to strengthen the other side has to have weakened. The US$ was strong while it looked like the Federal Reserve was intent on raising interest rates and at the end of last year various Fed members were talking about four interest rate hikes over 2016. As we’ve talked about in the past, the rising US$ was not good for the global economy and once Governor Yellen, the head of the Fed, backed off things improved.
What’s interesting is the drop in the A$, Yen and NZ$ over the past couple of weeks – a signal the market thinks the US might be closer to raising rates. Last weekend, in a closely watched speech, Governor Yellen said “the case for an increase in US short-term interest rates has strengthened in recent months”. This was backed up by a couple of her deputies saying effectively the same thing as well as pressure from the various state-based reserve banks. Following Yellen’s speech the market odds of rates going up in the September FOMC meeting doubled to 40% and it’s looking more and more likely. Given what happened last time the US$ strengthened, that could put a cat amongst the pigeons.