August was the fifth successive month of growth, albeit modest. With earnings season finished we can now make some overall observations. Earnings per share in the second half of financial year 2019/20 fell by 38%. The worst of the earnings fall in the 2008/09 GFC was about 20%. This health induced recession has caused carnage.
Overall the full year 2019/20 earnings per share numbers were down by 16% and dividends were cut by 30%. In addition there were balance sheet write downs of $25b. Some write downs will have been necessary, others will abide by the old adage “if you are going to have a bad year – make it a really bad one”.
Cheap stock valuations are largely unchanged but the growth stocks valuations have spiked. We are unconcerned if this is due to their underlying earnings growth and competitive positioning. Markets pay up for growth when there isn’t much – but the valuations look high.
Markets have recovered as investors have increased the earnings multiple they are prepared to pay for stocks. In fact 55% of the decline in overall earnings has been made up for with paying more (for lower earnings). When you dig into the numbers you find the following.
|Earnings Change||Valuation Change||Earnings Recovery Priced In|
Financials ||-25%||+ 5%||20%|
Table source: Goldman Sachs
What this means is that people are prepared to give industrials companies the benefit of expecting a healthy “bounce back” in the coming year or two. In effect they have been prepared to pay up in advance of the earnings recovering. The flip side is that the earnings recovery is seen as a “sure thing” – so there is less to gain.
Resources are expected to recover their earnings by 65%. There have been selective upgrades in some commodities, but investors aren’t yet believing in it enough to pay for all of it. Oil, Copper, and Iron Ore have made great recovery strides and Natural Gas is now bouncing. Imports into China are showing strong growth in crude oil, iron ore and copper. Coal, refined oil products and natural gas volumes are also up on the same period a year earlier. If China doesn’t boycott Australian resources this segment looks interesting.
Bank earnings are not expected to recover previous earnings. The market is only paying for about a 20% recovery in earnings that have been lost. Clearly, Financials are not being seen as a safe bet for earnings. As discussed previously we are concerned at the impact of the government exerting influence on the banks to be “generous” at the expense of shareholders.
Retailers did well out of the pandemic with increased profits. The spending pattern on non-discretionary items appears to coincide closely with government payouts and the Super withdrawals. We don’t expect these will continue into the future. Australian businesses and households have been saving in recent years in anticipation of difficulties. In fact, savings increased a lot since February – $160bn more than normal. A lack of places to spend money also helped. This is encouraging for consumption of consumption ahead. Will it be enough?
A recession is defined as 2 quarters of negative growth. This week the quarterly GDP was published and was worse than expected. The country is now officially in its first recession in 30 years. Without Government doing its job with welfare this could have been much worse.
We continue to believe that February 2021 should see Australia at around 5% down from the pre-coronavirus highs. Along the way we will get our share of up and down and our financials will keep a drag on Australia exceeding those pre-covid levels for now.
If a real vaccine is found, people will get much less risk adverse and markets will jump.
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