Macro Intelligence: ASX reporting season preview

The ASX reporting period has begun. In this week's IG Macro Intelligence, we discuss what to expect from this earnings season, the key themes, and the current fundamentals for the ASX 200.

Low expectations but a high bar

Expectations for corporate profits this reporting period are low, but asset prices remain relatively high. Although on a trailing basis, price multiples appear in line with, if not slightly lower than, historical averages, a pessimistic outlook for economic fundamentals, and a run-up in prices over the last 12 months make valuations appear relatively rich.

The set-up has investors poised for further downside risk, especially given some concerning developments during the so-called "confession period," where companies will provide activity, production, and profit updates.

Most areas of the market have managed to deliver a positive nominal return over the past 12 months. The exceptions have been the interest yield-sensitive real estate, consumer staples, and healthcare sectors. These have experienced multiple compression due to the run-up in government bond yields and the subsequent safer income investors can find in "risk-free" assets.

Returns over ASX 200 sectors

Strikingly, cyclical areas of the ASX 200 have performed strongly in the past financial year, despite moderating economic activity across the globe. After a challenging 2022, the information technology sector has been propelled to the top of the market as local tech stocks regain traction, primarily due to the borderline mania in Wall Street tech names inspired by the artificial intelligence boom.

The key themes to watch

• Weaker domestic growth

The outlook for the domestic economy will be the key issue during this earnings period. After unprecedentedly aggressive monetary policy tightening from the RBA, the markets are braced for an inevitable slowdown in economic activity as consumption declines.

Australian household spending chart

So far this year, despite historically weak confidence, households have proven resilient and generally willing to spend. This is probably due to the high savings built up during the pandemic, persistent "revenge spending", especially on leisure services, and historically low unemployment.

Concerning signs have emerged in company guidance among consumer discretionary companies, however. The likes of Ardent Leisure, Adairs, Bubs Australia, and a handful of others have sliced profit guidance in recent months as households tighten their belts due to the cost of living increases and higher interest rates biting.

ASX consumer discretionary spending chart

• Higher interest rates & costs

The impact of interest rate increases on corporates will also be a crucial issue during this reporting period. While higher rates will slow demand, companies face headwinds from high debt servicing costs and higher hurdle rates to invest.

Although overall leverage is low among ASX-listed companies, the more than 400 basis point increase in the cash rate could put pressure on balance sheets. It may also disincentivise growth initiatives.

As observed from the US earnings season, higher interest rates have supported banks' bottom lines. Out of the Big 4, only CBA reports this period, warnings about a peak in net interest margins and weaker loan growth knocked CBA stock from record highs. Investors will keenly await insights from the bank about future margins and credit demand.

• Net interest margins

Corporates are also dealing with a higher cost base, which, combined with higher interest rate expenses, puts pressure on profit margins.

• Commodity prices outlook

A resilient mining sector has helped prop up the Australian market, even as underlying commodity prices have pulled back from elevated levels. The Bloomberg Commodity Index is 10% lower than a year ago; iron ore prices are flat over the year but have fallen to as low as $75 per tonne.

Bloomberg commodity index chart

Investors will look for comments about future Chinese demand for Australian exports as the country's fledgling recovery cloudies the outlook for iron ore prices.

A look at the ASX 200

The ASX 200 looks cheap, but earnings growth is moderating with risks skewed to the downside. According to Simply Wall Street, ASX 200 profits have expanded 10% from a year ago. Aggregate profits sit at $144.7b.

Australian market earnings chart

The trailing price-to-earnings for the index is also below the 10-year average of 23 times. However, that number is distorted by the substantial multiple expansion during the post-pandemic asset price boom. A relatively low price-to-earnings ratio of 17.1 suggests sluggish profit growth going forward.

From a technical standpoint, the ASX 200 is rangebound, with the market trading between 6400 and 7600 in the past 12 months. In the short term, the index is sitting just below resistance at 7400, which, if broken, could push the market toward record highs. Major support exists at 7000 and 6840.

Australia 200 cash weekly chart