On the Edge – a sell off on the cards?

Reporting season update

As the Australian reporting season moves to the busiest week on the calendar, let’s take a look at what factors have been moving the Australian stock market.

Earnings season to date has seen around 140 companies report for the FNArena calendar of stocks covered, with over 150 to report in the next 10 days.

Thus far, FNArena notes one of the highest earnings beat averages on record. Almost 56% of the companies to date have come in ahead of broker forecasts and only 12% have missed. Over 20% of stocks have had their share price targets upgraded.

A great result, but why have some of the share price moves been so out of kilter with the great results?

You always need to remember that unless a result beats the market’s expectations, or the company upgrades the outlook for the forthcoming year, investors are unlikely to reward the shares with a higher price. This is particularly true when some share prices have already run hard over 2020.

The same applies to what on the surface seems like a bad result, such as a large loss. If the earnings announcement is not as poor as has been anticipated, and earnings improvements can be expected in the year ahead, then all aspects of the share market being equal the share price will generally rise.

Expectations will always have a bearing and impact on the way share prices move whether that is up or down. In the US reporting season, some of the technology giants such as Apple delivered standout results and even beats, yet the prices have not reacted or in fact sold off. This has more to do with the macro-economic backdrop and what bond yields are doing than the results.

In terms of share price reactions in Australia, the results have been mixed with concerns about trading conditions in 2021 likely to impact on forecasts. Coles was heavily punished for its downbeat forecast and rising costs of an online transition (interestingly the US giant Walmart echoed similar thoughts and the stock price reacted negatively).

Ansell has been a standout winner with an earnings beat and a corresponding lift in the share price. Whereas some of the other beats such as Amcor are still trading in the doldrums and Ansell is almost 16% off its share price target according to FNArena.

Benefitting from the high iron prices, BHP announced a better-than-expected interim dividend of US$1.01 per share and is currently trading on 6% 2021 dividend yield. How the times have changed.

Australia continues to receive a free kick so to speak (with record exports) from ever higher iron ore prices. Copper is at a 9-year price high and there is talk of the start of another materials super cycle, driven up by the strongest recovery in US GDP growth in decades and a renewable energy/ infrastructure boom from the Biden administration. These factors bode well for the big Australian, but much has already been baked into the current share price at $48 according to analyst share price targets.

Results such as BHP and the rising oil price (helped by production constraints from a record winter storm in Texas and other past of the USA) place the reflation trade firmly back on the agenda for investors. The momentum switch out of the more expensive technology, healthcare and defensive stocks, as cited in Shareplicity’s January BLOG article “What’s on the horizon for 2021”, has continued over the month of February.

Market darling CSL reported a winning 2020 result from record profits in Seqirus, the flu vaccine division, but the pandemic clouds the ability to collect plasma supplies in the US and this is overhanging the 2021/22 outlook. The share price is likely to struggle until plasma collections pick up and there is more certainty of supply.

Resmed remains a great long-term digital health story, but the share price is struggling with concerns of reduced demand for ventilators in a vaccinated world. Cochlear’s lower than expected losses and a more robust outlook helped lift the share price.

Housing in Australia looks set to boom if the Reserve Bank forecasts are to be believed, and the wealth effect from rising house prices should at some point lead to higher spending from Australians who have been busy saving over the last 12 months.

Housing-exposed shares such as Adairs, Temple and Webster, Nick Scali and even Baby Bunting could continue to be strong performers. The effects of the removal of Job Keeper at the end of March remain to be seen, but barring more lockdowns, the vaccine related re-opening trade should support specific retailers in the house sector. James Hardie remains the quality cyclical pick in the building materials sector and over 12% below the concensus share price target.

Continuing on the housing theme, rising bond yields and improved economic conditions have popped the good old favourite, banks, back in the dress circle. With the annus horribilis behind them, and the housing sector in an uptrend, banks are revising up earnings and dividend payments are back at 4% plus fully franked yields.

The macro-economic picture driving share prices

The steep rise in the US 10-Year Treasury yield from just over 1% at the end of January to 1.36% in February is accelerating the flight to materials, energy and financial stocks. If the markets continue to price in higher inflationary expectations, the US 10-Year Treasury will move even higher with a next stop at around 1.5%.

Higher interest rates, as indicated by the US 10-Year yield, are not bad in isolation for equities. (One of the longest equity bull markets in the US from 1990 to 1997 had interest rates from 5% to 8%. However, over the course of the decade the trend was from higher to lower.) This time the world is potentially moving from record low yields (zero to negative) to a reset around 2% to 3%.

Over the course of 2021, many expert commentators are expecting the US 10-Tear Treasury yield to rise by year end to anywhere from 1.5% to 2%. These levels are not a concern in a general sense. However, the speed of the rise, i.e. 30% in one month in the US and in Australia up 34%, is what can cause investors to sell equities and lock in profits.

If you are wondering why you are seeing some uncharacteristically wild moves in share prices you need look no further than the movement in the bond prices.

This is a topic that will be explored in more detail in my new book Shareplicity 2, a simple approach to investing in US shares (being released in July 2021). In a nutshell, rising bond yields –particularly the US 10-Year Treasury – set the stage for the rise in the cost of capital.

Lower rates or a lower cost of capital make shares more attractive as the return on the bonds is falling or you receive less on deposit in the bank. Conversely, when bond yields rise, investors take profits in growth companies in particular and move to more cyclical value shares to benefit from the improved uptick in economic activity.

If the bond rates move too quickly, then share markets across the board will sell off with the biggest falls expected in the shares that are the most expensive.

Did anyone say “sell-off”?

Shareplicity talked about the possibility of a sell-off at some stage in the last BLOG, predicting that ‘when’ is impossible to gauge.

If you don’t have any cash on the sidelines, then maybe taking some profits is not such a bad idea. I am still sitting on some cash and although I added a few weeks back to some of the more cyclical shares including Westpac and Super Retail Group, I will be looking at those shares that are overly punished in reporting season to pick up a bargain.

Looking ahead, much of the move in shares will most likely be driven by bond yields and, in Australia, the strength or weakness in the Aussie dollar.  A strong Australian dollar versus the US dollar is bad for those companies that generate earnings in US dollars (e.g. healthcare and industrials such as Amcor and Ansell).

I suggest you keep a look out for what the bond markets are doing and use any share market falls to buy your favourite stocks, even the higher growth technology shares, as looking through the cycle these companies should continue to be good performers. I am personally yet to be convinced the world will experience a 1970s style inflation problem.

Conclusion

Always remember share markets are forward looking and although most experts remain bullish on equities for 2021, it is unlikely the prices will move in a straight line.

Know your companies and look for sell-off opportunities. Try not to become caught up in the short-term share price movements as the share price does not equal the value or the prospects for the company.

By the March BLOG post, the upcoming manuscript for my next book Shareplicity 2 should be with my publisher and editors, so hoping you will continue to join me on the Shareplicity journey

DISCLAIMER – Shareplicity offers information that is only general in nature. It does not take into account your personal financial situation, needs or objectives. Nor does it take into account the financial needs of any specific person. You should consider your own personal financial situation and needs or seek financial advice before making any decisions based on this information

 

 

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