As the August reporting season draws near, a range of economic pressures have combined to create a ‘perfect storm’ for company earnings, according to SG Hiscock & Company (SGH).
In an outlook released by the firm this week, portfolio manager Tim Gough noted that businesses have recently been challenged by issues such as access to labour, wage increases, rising fuel costs and higher borrowing costs.
“All these things mean earnings will be under significant pressure over the coming financial year. You don’t want to be a large employer of people without the ability to pass on costs,” he said.
“It’s hard to see how consumer sentiment will not come under pressure given rising rates and living costs, and with it, a decline in discretionary spending. As such, downgrades are likely to follow.”
With the war between Russia and Ukraine, the European energy crisis and China’s COVID-19 restrictions, Mr Gough said that earnings had started to trend downwards.
However, he suggested that not all sectors have suffered equally during this period.
“The banking sector had been a recent beneficiary of the environment, as banks were in general releasing provisions which helped their bottom line. Plus, future interest rate increases were being factored into wider margins,” Mr Gough said.
“Along with the banks, the energy sector has outperformed, and have collectively driven this profound shift from growth to value-style investing. They don’t trade at high price to earning multiples. Banks have been a beneficiary of the underlying pandemic provisioning and commodities typically perform well in periods of rising inflation.”
Hamish Tadgell, another portfolio manager at SGH, pointed out that energy and utilities were the only two sectors to post positive returns in the 2022 calendar year so far. In contrast, the technology sector has fallen by nearly 50 per cent.
He said that the shift in inflation expectations and central bank narrative had been the catalyst for the surprising speed of the correction to date.
“Valuations have never compressed so quickly on rising rate expectations. The price earnings ratio of the ASX 200 Industrials has fallen 26 per cent from its highs in August last year,” Mr Tadgell said.
While central banks initially indicated that supply chain issues stemming from the pandemic and rising costs pressures would be transitory, Mr Tadgell noted that they had proved to be more persistent.
As a result of these issues, coupled with supply side shocks from the war between Russia and Ukraine, he said that central banks had been forced to act more assertively.
“The challenge is that central banks are largely impotent in controlling supply side issues. They cannot print more oil or wheat,” said Mr Tadgell.
“By raising rates, they are looking to tighten financial conditions and take some heat out of the economy to control inflation. In effect they are looking to dent demand, which brings with it risk to company earnings.”
