The ASX 200 has corrected -7% since its recent peak of 5,600 points on August 1. We think it makes sense to re-visit the market fundamentals.
To better understand the fundamental value of our stock market, we need to review the Australian reporting season just passed. Our strategy team made the following comments on the reporting season:
Evidence of a softening domestic economy
Economic bellwether CBA noted the slow ongoing transition of the Australian economy. It sees stable (albeit weak) underlying GDP growth and stable employment, but notes that households and business are hesitant to respond to monetary stimulus. CBA expects ‘more of the same’ as the most likely scenario, but with risks skewed to the downside.
Fewer large cap hits
Far fewer large-cap companies beat market expectations compared with recent reporting periods, with only 11% of ASX50 Industrials stocks surprising the market to the upside. This reflects deflationary economic forces and sector specific issues (e.g. intensifying supermarket competition) making it harder for Australia’s largest corporates to grow.
But fewer misses
Conversely, the proportion of disappointing results was significantly lower for both large and small caps. This isn’t too surprising as:
1) Expectations had been progressively lowered heading into August;
2) Consensus expectations were more tightly dispersed than usual; and
3) Corporates are cycling flatter (more predictable) outlook guidance.
Tepid profit growth
Results met expectations overall, however, industrials companies will only record profit growth of around 5% in FY16, which looks uninspiring when measured against a forward price-to-earnings multiple of over 16 times.
Corporate confidence eroding
The quality of company outlook statements and earnings guidance continues to deteriorate. We reported a sharp step-up in companies now either not quantifying or not offering forward guidance. Again this reflects higher economic fragility/uncertainty.
Given current high PE’s on the ASX 200, it’s reasonable to see a bit of breather on stock markets in September ahead of two key macro events - the FOMC meeting on 20-21 September, and the US presidential election in 60 days.
These two events are related. Let me explain.
The market is currently pricing in just 20% chance of FOMC rate hike. It’s basically telling me that if the Federal Reserve goes for a rate hike next week, it will be a big surprise to the stock market (and the Fed will get cursed like the RBA did when it hiked rates before 2007 Federal Election). The US stock market could then get sold off more heavily, given its high PE. The panic could create market volatility to our Australian Stock Market.
However, this market volatility does not really change the fundamental value of our ASX 200. Based on reported earnings, the fair value of ASX 200 is valued at 5,460 points and as such, the selloff could be seen as buying opportunities. When to buy? I will be adding to equity positions once the index falls below 5,200.
This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.