Reece Birtles
Company results and communications from the recent August 2024 reporting season echo the poor conditions experienced back in 2019, according to Chief Investment Officer at Franklin Templeton specialist investment manager Martin Currie, Reece Birtles.
“The last 12 months’ returns for the key indices suggest the market is behaving as if a ‘Goldilocks’ economic landing is actually possible. Investors appear overly hopeful about the positive impacts of lower inflation and interest rates, ignoring the fact that lower inflation means a less desirable, slowing sales environment as consumers spend less,” Birtles said.
Current market price reactions to reporting season appear to be disregarding any evidence that contradicts the ‘Goldilocks’ narrative for the economy, leading to rising stock prices without the support of earnings growth.
Martin Currie conducted more than 100 meetings and engagements with company management teams during the reporting period and observed a disconnect between the share market exuberance and feedback from management.
“In our company engagements and visits, we noted general feedback that consumer demand weakness has now joined business demand weakness as a key issue. In previous reporting seasons consumer demand had been resilient and enough to maintain margins,” he said.
For the S&P/ASX 200 stocks that Martin Currie covers, they have assessed management guidance tone to have a two to one negative skew below what brokers were expecting before the results.
Not surprisingly, this has led to more than 40% of companies receiving downgrades to their EPS forecasts versus only a quarter receiving upgrades.
The biggest driver of the weak guidance from management was the slowing inflationary environment that everyone seems to be wishing for, which is making it a lot harder for companies to maintain or grow EPS.
“Given slowing inflation and poor revenue growth, pricing power and gross margin management have saved the results of many industrial companies, but with selling prices falling, it is making for quite a difficult margin expansion environment for many companies going forward,” Birtles said.
In some good news for companies, labour has gone from being one of the top headwinds to earnings, in terms of shortage and cost, to no longer being a constraint, or to even being an opportunity. Unfortunately, rising unemployment will eventually be a factor in dampening demand.
In the current market environment, Martin Currie believes that growth-style stocks remain expensive, while value stocks are still cheap relative to historical standards.
In this market, focus should be on companies with pricing power, resilient volumes, and the capacity to manage margins, while avoiding those with valuation risk.
“Normally it is said that risky stocks are the ones that are cheap, but at the moment, safety is actually not expensive. We are finding undervalued names that have defensive business characteristics or profit drivers less related to the broader economic cycle,” Birtles said.
Examples of these kinds of companies include South32, which has undertaken a significant business transformation focussed on copper and other materials needed for the energy transition; Worley, which will benefit from increased spend in renewables in future years; and Flight Centre Travel Group, which has made significant business efficiency improvements and is seeing ongoing demand growth.