Currently, there seems to be a divergence between the market’s recent performance relative to the strength of corporate Australia. Our market continues to trend higher, more specifically reaching an 11½ year high and less than 4% from an all-time peak last seen in November 2007. With the ASX200 on a forward PE of 17 times compared to a historical average of 15x, it is fair to suggest that the market is not cheap.
Over the past month, corporate Australia has shown real evidence of coming under strain, supported by several indicators pointing to a slowdown in economic activity. We received confirmation that something was awry mainly due to the absence of earnings upgrades shared at the annual Macquarie conference held in April. The conference sees several market leaders provide updates on their companies, with many taking the opportunity to upgrade previously disclosed guidance. This year, however, upgrades were minimal, and after the event, several high-profile businesses provided less than flattering updates, leaving investors to establish a view that earnings growth may be topping out.
Often the canary in the coal mine is new car sales. So, with both Automotive Holdings Group (AHG) and AP Eagers (APE) recently releasing disappointing updates investors should take note. Though cynics may point to a potentially softer outlook as an attempt to ease ACCC approval of APE takeover for AHG, following 14 consecutive months of declining new car sales across the industry this outcome is not surprising.
Business spending is becoming more selective and has exacerbated the trials and tribulations of traditional media with Seven West Media (SWM) and Macquarie Media (MRN) both providing disappointing revenue updates. Even in the modern world of IT with heightened risks of cyber-attacks, security services firm Citadel Group (CGL) delivered a disappointing update as contract delays hit the bottom line.
Cement maker Adelaide Brighton (ABC), materials business Wagner Group (WGN) and plumbing provider Reliance Worldwide (RWC) all provided disappointing revenue updates, highlighting tough conditions for the construction market. Lighting retailer Beacon Lighting Group (BLX) and even the once bullet proof Dulux Group (DLX) released softer earnings guidance, though in the case of the latter a takeover offer from the Japanese owned Nippon Paint insulated the price decline.
Consumers are also telling us they are not as optimistic with a raft of discretionary businesses under pressure. Companies such as BWX Limited (BWX), Flight Centre (FLT), The Reject Shop (TRS), SkyCity Entertainment (SKC), Experience Co (EXP) and even petrol retailers, cum-retail outlets Caltex Australia (CTX) and Viva Energy (VEA) have all pointed to sluggish performance. Generic drugs manufacturer Mayne Pharma (MYX) saw competitive pressures force it to release another disappointing update.
Our traditionally volatile climate has thrown up droughts and floods, which all impacted GrainCorp (GNC) and Incitec Pivot (IPL). While volatile markets impacted negatively on the expectations for Pendal Group (PDL) and Janus Henderson Group (JHC).
With many saying that we could see more downgrades in the coming weeks, two scenarios can occur for the market from here on in that investors need to consider. One is that somehow the outlook of our businesses suddenly changes and begins to improve to the point that they validate the market’s lofty levels. Otherwise, the other outcome is that gravity will kick in, and the market will revert to the quality of the businesses who are flagging tougher trading conditions.
But it’s not all doom and gloom. Companies are doing well in both strong performing sectors and the tough ones. Investors should be mindful that many of these beacons of strong corporate performance are currently priced for perfection and therefore also carry the risk of a sell-off should they disappoint, or a broader market sell-off occurs.
What should you do now?
We conclude that everyone should not panic. A low-interest environment, weak currency, and accommodative economic and business policies mean the outlook for shares long-term is still strong.
However, given the rising active risks as exemplified by recent downgrades, it is prudent to review the percentage of your total wealth allocated to the market relative to your stage of life and tolerance to risk. If you have made strong gains in recent times, then take some profits off the table and return to your desired weighting.
Be sure to keep a close eye on what your companies are doing in the current climate. This is a stock pickers market where the best quality businesses with manageable active risks will be the ones that outperform. And though this doesn’t immunise against volatility in the short-term, deploying your capital back at more reasonable prices into great businesses to seize an opportunity is advised rather than in ones that appear very cheap due to operational issues.
ELIO D’AMATO (@Elio_DAmato)
Elio D’Amato is the Executive Director at Lincoln indicators, a leading boutique fund manager and creator of Stock Doctor the complete share market research platform. www.lincolnindicators.com.au