Economy slowing as cracks appear in corporate profits ahead of 2023

Corporate forecast profits remain stable after a resilient reporting season but there is some evidence of cracks forming, according to ECP Asset Management’s partner, Damon Callaghan.

Callaghan said that the qualitative outlook is becoming increasingly cautious.

“Although national retail sales data points to robust consumer sentiment and recent reports have showed record high sales volumes, consumer confidence has been deteriorating since earlier this year and corporates are preparing for a recession by reining in budgets.

“There is more pressure to come whether it’s in construction, consumer or enterprise software industries. Many companies have expressed concern that there is only so much cost increases that can be passed through to the customer. The rest will need to be absorbed by companies taking a lower margin,” said Callaghan.

As a result of increasing inflationary pressures, corporations have begun announcing pull backs on labour hiring plans with some companies already announcing job cuts, for example in the software and technology industries.

“Australia is trying to deal with this labour issue through migration, and has already increased the permanent migration cap as well as relaxed post-study work rights for international students. In effect we should expect that the reopening of borders should ease some blue-collar shortages that we have seen in the past 12 months,” said Callaghan.

Sam Byrnes, partner at ECP, said that the inflationary pressures introduced by global supply chain disruptions appear to be easing but other major inflationary pressures remain.

“Inflation will continue to be a feature in the markets in the next 12 months.

“The key to navigating this environment is to be macro-aware but not macro-led. Economic views should not dictate the investment process, as the success of such an approach means being correct in your economic views but also understanding what the market is already pricing in and how this will change as new economic data becomes available.

“The past 12 months presented opportunities for management teams of businesses to grow and prosper and that is key in evaluating a company’s long-term sustainability.

“Investors should focus their strategy on building a bottom-up portfolio composed of businesses that can compound their profit over time and that are not dependent on the economic cycle to drive business growth.

“Be cautious on near-term growth forecasts and valuations, but keep in mind the 3 key factors when stock-picking; business quality, balance sheet strength and structural growth,” said Byrnes.