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FY23, the Year That Was
FY23 once again reinforces the old adage that “the stock market is not the economy” as the ASX All Ordinaries rose 14.8% despite a plethora of macroeconomic events including but not limited to:
- The most severe interest rate hiking cycle seen since the late 1980s
- A US regional banking “crisis”
- The collapse of Credit Suisse, a 167-year-old global financial institution with over a trillion dollars in assets; and
- Persistently high inflation, leading to what many are declaring a “cost of living crisis” for many Australian households
A deeper look at the composition of returns for ASX investors shows that the bulk of gains were due to an expansion in the Price to Earnings (P/E) multiple, which begs the question…why are investors happy to pay a higher price for stocks today despite the clear pressures building within the economy?
Source: Stock Doctor, Bloomberg
The obvious retort would be that FY22 saw an abnormal contraction in valuations and share market performance, hence FY23 was merely a revision on the historically poor prior year. Perhaps a more optimistic investor would point to what appears to be a “peaking” of inflation for the Aussie (and Global) economy, as the June quarter headline CPI print came in below expectations at 6% year on year (yoy), which could evidently lead to a “soft-landing” scenario rather than a full-blown recession which many economists were previously predicting.
Source: Stock Doctor, Bloomberg
But FY23 Isn’t Over Yet…
Whilst 30 June has passed and the performance of the stock market has been cemented for the financial year, we cannot underestimate the importance of this upcoming FY23 reporting season.
Firstly, we need to deal with FY23 earnings.
As it currently stands, earnings expectations for FY23 are largely flat, with growth in industrials and financials overshadowed by the decline in resources caused by falling commodity prices and higher operating costs.
Source: Stock Doctor
We feel as if these headline figures do not tell the full story, and there appears to be a level of complacency within the market heading into these important results.
Consumer conditions appear to be deteriorating as many retailers have been quick to provide pre-emptive guidance, well below what was previously expected by consensus. Companies such as Universal Store (UNI), Dominos Pizza (DMP), Adairs (ADH), Baby Bunting (BBN) and Dusk Group (DSK) have all suffered from material downgrades, despite many of them producing stronger than expected 1H23 results.
Even defensive industries such as Healthcare are susceptible, with Ansell (ANN), CSL Limited (CSL) and Capital Health (CAJ) all providing early indications that profits will not be as high as consensus was forecasting.
Some of the underlying data we have observed that supports downside risks to earnings this season include the ANZ Roy Morgan Consumer Confidence Index, which remains very weak and has spent 20 consecutive weeks below 80 points. This is the longest stretch below 80 since the index began being conducted on a weekly basis in October 2008 (previously monthly).
Source: Roy Morgan, Factset
And Now for FY24 Earnings…
It is possible that conditions remain subdued for FY24, as we are yet to see positive indicators turn positive in our economy. In fact, higher-than-expected services inflation (rents, insurance, wages etc) indicate that interest rates could remain higher for longer, despite having a lower terminal rate, which would place both revenue growth and profit margin expectations in doubt for the following year (contrary to what is being priced in by the market).
So how should your position yourself for the year ahead?
The largest threat to corporate earnings going forward is the elevated risk of a global recession. And if this occurs, earnings expectations are likely to move lower. Since the start of the year earnings expectations have fallen by about 5% but historically, the average decline in earnings during a recession tends to be closer to 20% as highlighted in the table attached.
So, what does all this mean heading into the reporting season. There could potentially be further earnings downgrades to come. We have already seen a deterioration in the Financial Health of the market over the last two years and we believe more companies will become financially unhealthy – especially across sectors in exploration mining, biotech, building construction, manufacturing, and retail. You can keep track of the change to the financial health of the stocks in your portfolio by using the change alerts under the alert manager.
Hence, it is important to focus on risk management and play defence across your portfolios – be wary of having exposure to high-risk speculative businesses.
Ends
