When shares climb to record highs without a meaningful improvement in company profits, the market will eventually enter a ‘correction’, marked by significant falls.
Share price volatility reigned this company reporting season, with big swings for ASX-listed stocks despite most profit results meeting analyst expectations.
The month of August saw the usual deluge of results from corporate Australia and alongside it came large swings for stock prices, in both directions, on the local share market.
It was among the wildest reporting periods on record, with more than 30 per cent of ASX 50 firms moving by more than 3 per cent on results day, according to JP Morgan, which described it as “gale-force volatility”.
While the price movements were suggested otherwise, it was a season of fewer-than-usual surprises.
According to analysis from the investment bank, 55 per cent of companies delivered results in line with market expectations — that’s above the average of 39 per cent in-line results over the previous five years.
Just shy of a quarter of companies missed expectations, while 21 per cent beat them.
Over August, the benchmark ASX 200 index gained 2.6 per cent, repeatedly hitting fresh highs.
JP Morgan’s Australian head of equity research Jason Steed described it as a “rally built less on earnings substance than on sentiment, flows, and a sense of optimism”.
However, there is not a whole lot of optimism around the outlook for corporate Australia, with only 18 per cent of companies having their forecast earnings upgraded by analysts, compared to 36 per cent experiencing downgrades, by JP Morgan’s estimates.
Analysts at UBS agreed that revisions to forward earnings estimates were skewed to the downside, with their number-crunching showing five upgrades for every six downgrades.
“The median stock saw forward earnings downgraded -0.4 per cent post-result,” UBS equity strategist Richard Schellback and analyst Lily Huang noted.
Large swings for the large companies
Portfolio manager Elfreda Jonker told The Business it was one of the most volatile earnings season she could remember, with more than 40 per cent of companies seeing a stock price move of plus or minus 5 per cent on the day of reporting.
Ms Jonker, from Alphinity Investment Management, said that was around double the long-term average.
“It’s really just a testament [to] very high valuations not leaving a lot of room for any disappointments,” she said.
CommSec data for the biggest gains and losses on the ASX 100 over August shows just how volatile trading in many of Australia’s largest companies has been.
However, Julia Lee from FTSE Russell noted it was not an even reaction across the market, with outsized moves correlating with company size.
“If you exclude the large companies on the market this reporting season, you’re actually seeing a better share price reaction.
UBS analysts said they were not surprised to see the outsized share price volatility through the reporting season.
“To us this is structural, and reflects the combination of rising passive ownership, the increased prevalence of quant driven trading strategies, and stale earnings estimates,” Mr Schellback and Ms Huang wrote.
The increase in passive investment through index and other exchange traded funds can lead to bigger market moves, as funds have to trade stocks in order to keep mirroring the indices they track.
Similarly, quantitative trading is based on mathematical models and data analysis, in some cases relying on artificial intelligence or algorithms, and can see stock moves snowball if a share price goes past a certain threshold, for example.
“A number of ‘blue chips’ suffered record or near-record on-day declines,” a JP Morgan analyst said.
Two major victims of share price sell-offs were biotech giant CSL, which ended the month down 21 per cent, and building materials firm James Hardie, which lost nearly 25 per cent in August.
Morningstar equity analyst Lochlan Halloway argued the heavy sell-offs, after such strong runs in recent years, has left both stocks “looking undervalued”.
“We think that while they posted two, you know, somewhat disappointing results, the market reaction was far too heavy handed and we see a rare opportunity for those two.”
“CSL was a very disappointing one, which impacted not only on the healthcare space, but as a top three company on the Australian market, really impacted on market,” Ms Lee noted.
Mining earnings down, consumer confidence up
In terms of sectors, Ms Jonker noted weaker-than-expected results from miners and energy producers, with Alphinity remaining underweight on commodities stocks.
However, mining stocks performed well over the month, including BHP (+10% in August), Rio Tinto (+3.4%) and Fortescue (+8.6%).
“Looking at the share price reactions, you wouldn’t know that profitability, as well as earnings, has fallen quite substantially for these businesses over the last financial year,” Ms Lee told The Business.
“In fact, we’ve seen earnings down by 8 to 26 per cent,” she said.
Ms Lee said the outlook for the basic materials sector has stabilised, given China’s improved outlook.
“We’ve actually seen some of the miners are doing well and we have also seen the materials sector outperforming the market over the last three months.”
As interest rates and inflation come down, consumer confidence has picked up, which was reflected in the company results.
“I think the consumer stocks have definitely come through better than what the market’s been expecting,” Alphinity’s Ms Jonker said, after a “very cautious” 12 to 18 months for consumers.
Trading updates for the early weeks of the current financial year were a key focus, with Ms Jonker noting many came through a lot better than expected.
UBS analysts agreed that trading updates for sales since June 30 reflected strength in the domestic economy, with sales up 3.8 per cent compared to the same time a year ago, for 22 retailers they tracked.
Through August, corporate Australia told us that the domestic economy is no longer ‘just resilient’ (which had been the familiar story for much of the last three years), but is actually showing signs of recovery,” the UBS analysts noted.
However, it was not one-way traffic for stocks in the sector — for example, Coles shares gained 15 per cent in August, while rival Woolworths lost 8.6 per cent, after wiping $5 billion off its stock market valuation on results day.
Will ASX valuations ‘come back to Earth’?
While the share price moves have been extraordinary, by most accounts the profits have been fairly ordinary, leaving one question on market-watchers minds — can the market sustain its positive momentum?
“When we think about the last few years on the ASX, we’ve had, since mid-2022 share price gains of about 40 per cent across the ASX 200,” Morningstar’s Mr Halloway told The Business.
“But across that time earnings have basically done nothing. In fact, for our largest companies, they’ve actually gone backwards.”
As Morgan Stanley strategist Chris Nichol put it, the index pushed all-time highs “whilst market earnings levels plumb lows”.
FTSE Russell’s Ms Lee said the price-to-earnings ratio for the local market, which has risen from 18-times earnings a year to 22-times earnings, signalled “a bit of a disconnect between the valuations of companies and what’s happening in the underlying economy”.
“It means that the market’s driven a lot through sentiment and at some point you want to see earnings catch up or you’ll see probably valuations coming back down to Earth,” Ms Lee said.
Mr Halloway estimated the ASX was around 10 per cent overvalued at current prices, which he described as not “crazy levels of valuation”.
“We have been here before and it doesn’t necessarily portend to a crash or a correction, but it does suggest that investors are baking more into share prices in terms of earnings growth than we expect.”
He noted that a common measure of volatility, the VIX index or fear gauge, is relatively low despite the up-ending of global trade by the Trump administration.
“That’s a big change and it brings us back to a level of US trade restrictions we haven’t seen in 100 years, yet US equities and Aussie equities keep climbing higher and higher out of the trough we saw back in April.
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