Rudi’s Comprehensive August 2022 Review

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Download related file: FNArena-Reporting-Season-Monitor-August-2022

A compilation of stories relating to the August 2021 corporate reporting season in Australia, including FNArena’s final balance for the season.

Content (in chronological order of publication):

-Quo Vadis, Corporate Profits?
-Not The Bottom, Not The End
-Conviction Calls
-Corporate Profits – The Next Challenge
-Reporting Season: Early Signals
-Corporate Earnings: Between Dr Jekyll & Mr Hyde
-Conviction Calls
-August Preview: Curve Balls, Profits & Forecasts
-Conviction Calls
-August Results: First Blood
-When Forecasts Are Too High
-August Delivering More Downgrades And Misses
-What Happened To That Recession?
-August Reports: Closing Remarks
-Conviction Calls
-Conviction Calls

By Rudi Filapek-Vandyck, Editor

Quo Vadis, Corporate Profits?

Bad things tend to happen when global economic growth dips below 3%. In recent days I have been alerted to this historical observation by multiple economists and market analysts, so I thought it is worthwhile highlighting this point.

GDP forecasts around the globe are in decline, with many a forecast now sitting marginally above 3% for the global economy this year and next. This makes that historical observation potentially even more important.

One key ingredient to those forecasts is, of course, how much central bank tightening needs to occur to bring consumer price inflation back under control.

Truth is, we don't know. Which is why traders, investors and central bankers are all watching the data very closely.

Markets Oversold In May

Global equities had looked technically oversold for a number of weeks, but that interview by Fed Chair Jerome Powell to the Wall Street Journal mid-month had kept a firm lid on overall enthusiasm to start piling back in.

'Don't fight the Fed' has a different meaning this time around.

Investors needed a bit of extra time to fully digest the new Fed narrative. Controlling inflation is now of the uppermost importance (see also further below).

When markets are oversold, the smallest hint of optimism can trigger the next rally. Last week US indices rallied more than 6% to post their best week for the calendar year to date. According to the latest economic data, the all-important US consumer remains eager to spend, even if this means he/she has to dip into savings.

And there are quite a few suggestions that inflation is no longer poised to keep surprising to the upside, despite expectations for higher energy and materials prices in the quarter(s) ahead.

Peak Inflation Anxiety?

Reduced anxiety about inflation in particular might be the most important development in May, if it proves to be accurate. It implies that bond yields might have peaked already, as also shown by the US ten-year yield declining towards 2.75% from 3.10% earlier.

A more relaxed US bond market might allow equity markets to become less volatile, in a general sense, but it will also allow those market segments that had previously de-rated to shift back onto investor radars.

Think bond proxies such as REITs, property developers and infrastructure owners, but also Quality and Defensive Growth stocks that traditionally trade on higher valuation multiples.

In Australia, I note both Carsales ((CAR)) and Goodman Group ((GMG)) shares are back above $20, while the likes of Cochlear ((COH)), NextDC ((NXT)) and IDP Education ((IEL)) are well off their lows.

One cannot argue with 'hope' and it is very likely equity markets will adopt the view that if central bankers can relax more about further momentum for inflation, they don't have to stick with their intentions for aggressive tightening. This reduces the risk for over-tightening, and thus for an economic recession.

Not everybody is on board with this reasoning, as also illustrated by the latest comment from the economics desk at Citi:

"Markets are increasingly reflecting the idea that slowing growth will lead to a more dovish Fed policy rate path. We disagree with this assessment and see risks still balanced toward a more extended period of above-target inflation requiring a further tightening of financial conditions."

I still remain a bit wary myself, not in the least because the Federal Reserve will also embark on Quantitative Tightening (QT), i.e. actively selling bonds. Nobody knows what the impact of additional liquidity withdrawal will look like, but we are going to find out.

Corporate Profits: The Next Concern

In the background of this year's Grand Debate about inflation, interest rates and bond yields, and the impact of it all on housing markets and economies in general, investor focus is already turning towards corporate margins and profits – the next Big Challenge for equities this year.

It is this second challenge that keeps me worried about the outlook for equities.

Simply put: markets have devalued on a normalisation in bond yields, which has pulled down the 'P' in average Price Earnings (PE) ratios. But now we will have to deal with the 'E', earnings (profits), and outside of energy producers and bulk commodities coal and iron ore, the trend has already turned negative – globally.

These are slow-moving processes, and more downside should be expected, if only because inflation is slow-moving too, and multiple challenges remain amidst slower economic momentum.

In the US, where super-margins and super-profits previously combined with outsized gains and valuations, the simple observation is the Q2 reporting season failed to inspire. In about six weeks, US companies start releasing their Q3 financials.

It's going to be interesting, to say the least.

In Australia, we don't have extensive quarterly reporting and the 50-odd, mostly mid-cap companies that report in between February and August are not representative for the bulk of the local share market.

Investors have seen a number of profit warnings coming through, mostly issued by companies of questionable quality or of a relatively small size, bringing home the old truth that smaller companies are more vulnerable to economic challenges.

I do expect to see a lot more "confessions" as the financial year draws to a close and the August reporting season beckons.

It is not always easy to spot the next profit warning coming, and many a share price has received quite a shellacking already, for general fears of lower profits or otherwise.

Analysts at UBS recently pointed out commodity-related costs for their universe of companies throughout the Asia-Pacific have gone up by 29% year-to-date.

Conclusion: "With operating leverage fading and the impact of cost increases typically taking three months to feed into margins, the risk to earnings remains substantial at least over the next quarter".

Even more concerning is that UBS has placed Australia in the least favoured basket for the APAC region, suggesting ASX-listed companies are likely to fare worse than those in China, Singapore, Indonesia, Philippines and Malaysia.

Differences in pricing power means some companies are better equipped to deal with rising cost challenges than others. This is why, for example, packaging company Amcor ((AMC)) is trading near an all-time high when energy and commodity prices are running hot on supply constraints.

Unfortunately, the UBS research focuses mostly on companies in China, Japan and elsewhere, with only a small number of ASX-listed names mentioned. Imdex ((IMD)) is seen as a potential candidate for the next profit warning, while a2 Milk ((a2M)), Bega Cheese ((BGA)), Synlait Milk ((SM1)) and KMD Brands ((KMD)) have been nominated as likely beneficiaries for any sustained decline in commodity prices.

Another noteworthy observation relates to the latest global update by Citi which reveals Australia is one of few markets where average EPS growth is forecast to be negative in 2023. The reason is that following a stellar increase in EPS forecasts this year for the Energy and Materials sectors, Citi forecasts have both sectors retreating into negative growth next year.

That'll be the next challenge for investors; assessing for how long exactly may the current favourable environment last for what are, in essence, highly leveraged, cyclical businesses.

Meanwhile, Citi's Bear Market Checklist has improved on the back of lower share prices with only 6 out of 18 components flashing red or amber warning signals. At the end of last calendar year, the score was 8.5 or nearly 50%. Back in October 2007 the score was 13, while in March 2000 the list had 17.5 out of 18 indicators calling Mayday, Mayday!

The market sentiment indicator previously known as Citi's Panic/Euphoria Index, now relabeled as Levkovich Indicator, is not signalling equities are in Panic mode, but the indicator is not that far off, and a long while from the Euphoria that characterised 2021.

Citi's indicator has no bearing on short-term sentiment or market direction but at current level Citi suggests there should be good buying opportunities for investors taking a 12-months view or longer.

Market strategists at Morgan Stanley tend to agree with that assessment. They also believe equity indices are likely to face more downward pressure depending on how much lower corporate profits might fall.

And that, history suggests, is now the most important question of all: quo vadis, corporate profits?

Australian investors might have to wait a little while yet to find out, but the next US corporate results season is only 1.5 months away.

Not The Bottom, Not The End

"For people still in their prime earning years, this bear market is likely to be as bullish in the long run as it is painful in the short run. For older investors, the decline is potentially devastating."

Jason Zweig in the Wall Street Journal, last weekend.

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As the Danish proverb goes, making accurate forecasts is very difficult, in particular about the future. Which is but one reason why I think investors put too much emphasis on forecasts and their accuracy.

A much better strategy is to identify and manage risk. This can be done by shifting allocations away from more vulnerable and volatile parts of the portfolio to defensives and cash, taking on less risk when the overall environment looks to become increasingly challenging.

Thus far in 2022, defensives have not operated as they should have, as suggested by history and the label they carry. One explanation is every new bear market differs slightly from the past, generating its own idiosyncratic framework. Another explanation is this year's bear market is only in its infancy; there's a lot more to come.

Six months in, assuming we can all agree the current bear market started in January, and with circa 60% of the ASX200 down by -20% or more, it is but normal for investors to start wondering whether The Bottom is in.

Maybe a macro-dissection, top-down style, from the process thus far can provide us with better-than-guesswork guidance in this all-important manner?

The process thus far

Those who pay attention to the finer details, and who are able to maintain a broad, macro overview, could potentially argue this year's bear market for global equities started in the early months of 2021 – well before the calendar moved into a new year.

It was then that the more speculative parts of US share markets started to falter. Take Cathie Wood's ARK Innovation ETF, for example. Its price peaked in February last year, stabilised for a while, and then fell off the cliff from early November onwards. It's still an open debate whether that fall from unbridled adoration has now ran its full trajectory.

In hindsight, ARK's step-by-step demise was simply the first signal inside the post-covid process that today has pulled major US equity indices down by -20% and deeper. Once the more speculative market segments had received their first public flagellation, liquidity was subsequently withdrawn from US micro cap stocks, then followed the midcaps with smaller-sized technology stocks attracting most of the attention.

The process, by now, was no longer confined to publicly-listed companies. In the equally exuberant and speculative crypto markets, NFTs were the first to be pulled into the abyss, shortly after followed by other vulnerable assets and faulty crypto-finance constructions, before a general rout took over the whole crypto market.

By then, the world's mega-cap technology stocks were already part of the process, and pretty much every market around the world had joined-in.

In Australia, where the major index is dominated by banks, energy companies and miners, the global withdrawal of liquidity initially showed up mostly below the surface, leaving many an investor with the false impression that whatever bad was occurring internationally might not be repeated on the ASX.

Such an assumption ignores the fact the 2022 bear market is developing through multiple, distinctive phases. Phase one was all about pricing out the Grand Exuberance that had been running wild when both governments and central banks provided additional support for covid-hit economies and markets.

Phase two kicked in when bond markets started normalising from emergency-driven levels, as inflation forced central bankers to change course and start hiking interest rates. Sharply higher bond yields triggered a violent re-adjustment in every asset trading on historically elevated valuation.

As investors sought refuge in those sectors responsible for the jump in inflation, Australian investors might be excused for thinking they were once again operating from the Luckiest Country in the world.

However, understanding how this process is now moving into the next phase means one can see why Australian banks had to be the next shoe to drop on the ASX, and why oil & gas, iron ore, coal and gold miners will follow next, not necessarily in that order and with exact timing unknown.

The next phase: corporate profits

The next phase in this year's bear market is all about the R-word; recession.

While it might take a while yet before investors find out which regions exactly will suffer economic contraction as higher interest rates, the rising cost of living and falling asset prices (housing, equities, cryptos and bonds) will exert downward pressure on household budgets and business's spending intentions, one recession that looks most likely to arrive next is a recession in corporate profits.

Zooming in on elevated margins, just about every market strategist worth his salt is today predicting forecasts for corporate profit growth are too high, both in Australia as elsewhere. What we don't know is whether sharply lower share prices are already accounting for the downgrades that haven't been implemented yet.

One extra complication investors are facing is that economic processes tend to be rather slow. Take the Australian housing market, for example. Most economists are now in agreement in that accelerated tightening by the RBA will push property prices down in 2023. Whether this will be by -5%, or -10%, or -15% is by the by.

Given plenty of historical precedents and references, a fall in property prices next year seems but a plausible projection. The problem investors are facing is how do you account for this, and its impact on consumer spending, in 2022?

Meanwhile, the upcoming quarterly reports from US corporates might shine some light on ongoing supply chain disruptions, input costs, inventories and margin pressures.

In Australia, investors will have to wait until August, with the preceding confession season offering the ability to surprise either way. On Monday, shopping mall operator Vicinity Centres ((VCX)) issued an upgrade to its FY22 guidance, accompanied by an uplift in asset valuations, and its shares rose 6.3% on the day.

The shares are projected to offer a yield well in excess of 5% and had fallen almost -9% over the preceding two weeks.

In contrast, shares in auto-parts manufacturer and distributor GUD Holdings ((GUD)) fell by some -30% between April and last week, when the company issued a profit warning, causing the shares to fall by another -19%.

The experience with GUD Holdings once again pays tribute to that old Wall Street adage that a profit warning is never fully priced-in, irrespective of share price weakness beforehand.

The problem for investors, as I see it, is that it's not always possible in advance to distinguish the next profit upgrade from that painful downgrade. And thus the risk for owning equities at this point in this bear market remains too high for comfort.

This is not to say portfolios should be reduced to zero exposure, but investors should be prepared to suffer at least one disappointment and preferably stick with solid, less risky exposures – or make a conviction call with a long-dated horizon.

As per my standard view, a healthy allocation to cash in portfolios seems but appropriate and the best possible defence against left-field, unexpected disappointment. A reminder: each of Coles Group ((COL)) and Woolworths ((WOW)) delivered an operational disappointment earlier in the year, which led to instant pummeling of the share price. In both cases investors have been reminded that solid, defensive stalwarts are not immune from the pressures this year.

Anyone who's buying shares ahead of August better account for the risks involved. I recommend you limit your purchases to cautious nibbling, and remain patient overall. This still remains an environment in which heroic behaviour will likely not be rewarded and instead can result in immaculate pain and suffering.

We haven't even found out whether there's an economic recession on the horizon. It matters not whether you believe it can be avoided or not, what matters is that you reduce the risk of maximum pain in case of an alternative scenario than the one you are inclined to side with today.

As I like to remind everyone who strongly believes energy companies and large bulk miners are the new defensives in 2022 no matter what happens: let me check my notes, when was the last time that share prices in cyclicals held up while economies were facing recession..?

Oh, that's right! It has never happened before!

Gold and gold miners are at risk of central bankers achieving what they're aiming at: bringing inflation back inside the 2-3% range.

Rally potential in the short term

May and June have been extremely harsh on Australian equities with the ASX200 losing -11% over the past ten trading days alone. We don't need all kinds of sophisticated technical indicators to assess the share market looks over-sold in the short term.

This provides yet another platform for a broad rally upwards. Given the overall macro-context, however, I very much doubt whether this year's bottom is in, or whether it matters much for the months ahead.

On consensus forecasts, the local share market's Price-Earnings (PE) ratio has now fallen to circa 12.5x – a number not seen since the troubled Grexit period of 2010-12. But a crucial input to calculate today's number stems from analysts forecasts, which are almost by definition too rosy.

On top of all of the individual considerations, while inflation is still high and surprising to the upside, and central bankers are putting their feet on the accelerator, which means bond markets cannot settle anytime soon, I believe an investor's biggest enemy is his own impatience.

From where I am sitting, there is absolutely no hurry to allocate additional funds to equities right here, right now. Unless for trading purposes, or for longer-dated conviction calls.

Incidentally, anyone still holding some low quality, low conviction exposures in the portfolio might want to use the next rally to sell and increase the level of cash. This will come in handy no matter what scenario unfolds next.

Conviction Calls

One of the eye-catching share market observations recently was published by Model Portfolio guardians at stockbroker Morgans sharing feedback from institutional clients who have deep concerns about what corporate profits might look like for FY23.

In response to such concerns, reports Morgans, institutions are limiting their preferences to larger cap companies with plenty of liquidity. This means high quality companies in the smaller cap space are currently being ignored, opening up opportunities for other investors.

A word of caution: Morgans' Growth Model Portfolio is by no means heading all-in, but still anticipates a "tricky" market to navigate successfully and thus prefers a staged approach whereby smaller parcels are being bought in selected small and mid-cap companies that share those highly sought-after characteristics of being of high quality with good long term growth prospects.

Morgans specifically mentions Aristocrat Leisure ((ALL)) -a local Top20 stock, mind you- as well as Reliance Worldwide ((RWC)), IDP Education ((IEL)), Lovisa Holdings ((LOV)), Eagers Automotive ((APE)), and Domino's Pizza ((DMP)) among many more unnamed nominees listed on the ASX.

Morgans being a stockbroker, rather than a trustworthy journalist who acknowledges the value of precision and details, one smaller cap opportunity mentioned is PWR, but it's not clear whether this refers to PWR Holdings ((PWH)) or to Peter Warren Automotive ((PWR)).

I am inclined to think it's PWR Holdings, but would not be surprised if it applies to both companies.

Morgans, clearly, likes the re-born Woodside Energy ((WDS)) with both its Core Model Portfolio and Growth Model Portfolio buying additional exposure in May.

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Morgan Stanley's Australia Macro+ Focus List consists of the following ten constituents:

Amcor ((AMC)), Computershare ((CPU)), CSL ((CSL)), Goodman Group ((GMG)), Macquarie Group ((MQG)), Orica ((ORI)), Qantas Airways ((QAN)), QBE Insurance ((QBE)), Woodside Energy, and Telstra ((TLS)).

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The Model Portfolio over at Canaccord Genuity has adopted a more "cautious" view on the way forward for economies and share markets and this has translated into less exposure to the banks (now moderately underweight), the removal of cyclicals Mirvac Group ((MGR)) and Seek ((SEK)) and the inclusion of Endeavour Group ((EDV)) and recent Tabcorp-spinoff Lottery Corp ((LTC)).

The Portfolio has also moved to a moderately Overweight exposure to large cap iron ore mining with Rio Tinto ((RIO)) replacing Lynas Rare Earths ((LYC)).

Other stocks included are Woodside Energy, BHP Group ((BHP)), OZ Minerals ((OZL)), Amcor, Qantas Airways, Transurban ((TCL)), Woolworths ((WOW)), Ramsay Health Care ((RHC)), CSL, CommBank ((CBA)), National Australia Bank ((NAB)), Westpac ((WBC)), Macquarie Group, Medibank Private ((MPL)), Suncorp Group ((SUN)), Computershare, and Lendlease ((LLC)).

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"Citi economists see the risk of a global recession approaching 50%. The analyst consensus for 11% global EPS growth in 2022 and 8% in 2023 looks too bullish. Top-down, we expect 0-5% growth each year, but even that forecast will be too high if recession hits. Big profit downgrades would be a further drag on market performance, with cyclical stocks most vulnerable."

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"Macquarie’s Macro Strategy Team now expects most of the developed world (US, UK, Europe) to be in recession by 2023 as persistently high inflation forces interest rates into restrictive territory, ultimately resulting in slower growth and higher unemployment."

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Wilsons' Focus List has now removed Silk Laser Australia ((SLA)), while reducing exposure to Pinnacle Investment Management Group ((PNI)) and Judo Bank ((JDO)).

The strategist at the firm believes inflation is poised to fade over the next six months and thus warns investors against turning too bearish at this junction in the cycle.

Meanwhile, Wilsons' (freshly discovered) most preferred 'value' exposure is now Cleanaway Waste Management ((CWY)); the stock has been added to the Focus List. Weightings for CSL and Telstra have both been increased.

Wilsons new motto: "we think balancing the risk and return in portfolios is imperative to protect capital."

Other ASX300 members that, on Wilsons' analysis, look great value in June include Lendlease, Qantas Airways, Macquarie Group, Dexus ((DXS)), Goodman Group, GPT Group ((GPT)), National Storage REIT ((NSR)), IGO ((IGO)), Lynas Rare Earths, ALS Ltd ((ALQ)), and Domino's Pizza.

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From the latest strategy update by T Rowe Price:

"While equity valuations are more reasonable after recent declines, we remain cautious on the earnings growth outlook and inflationary impacts on margins supporting our modest underweight. Within fixed income, we remain underweight bonds and overweight cash."

"Within stocks, we closed our position in REITs due to higher yields and our inflation outlook. This allowed us to further narrow our value vs growth overweight position by adding to our growth equity portfolio where valuations partly normalized."

"…growth could be due for a spurt higher as many of the tailwinds for value—higher energy prices and rates—may be peaking."

Corporate Profits – The Next Challenge

The first six months of 2022 have not been easy to navigate for investors, but the next challenge might turn out to be just as tricky with analysts forecasts looking too rosy and companies potentially too optimistic about their ability to absorb the many changes happening while also maintaining their profit margin.

While much attention is going out to local retailers and other consumer-related companies, as share prices for the likes of Nick Scali ((NCK)), Super Retail ((SUL)), Temple & Webster ((TPW)) and Wesfamers ((WES)) might have been over-sold (at least for the medium term), one sector that has equally caused a lot of damage to investment portfolios is the local mining sector.

It was not simply a matter of macro-factor selling either as companies including OZ Minerals ((OZL)), St Barbara ((SBM)) and Dacian Gold ((DCN)) fessed up to what should have been on every investor's mind beforehand: miners might have been enjoying strong price rises for their raw products, but those companies in the field are equally users of electricity, diesel, gas, and other commodities, while higher transport costs and staffing problems, not to mention excessive rain on the East Coast and yet another wave of covid infections further add to operational risks.

Sure, the prospects of an economic recession in key countries next year should be on every investor's mind, but what about cost pressures right here, right now?

The team of metals and mining analysts at JP Morgan believes the upcoming reporting season won't be pretty for the sector, with cost inflation accelerating while worker absenteeism remains a problem too.

JP Morgan has now factored in more conservative forecasts, but still, the team is forecasting "the current doom-and-gloom to last through the July/August reporting season (negative news flow) before a more constructive macro backdrop (China reopening) helps support the sector".

More conservative projections have led to reduced valuations and JP Morgan reports the average cut in Net Present Value (NPV) has been -15% across the sector. Only one company received a downgrade in rating; Newcrest Mining ((NCM)) moved to Neutral from Overweight. OZ Minerals, post public shellacking, was upgraded to Overweight from Neutral.

While expecting the weeks ahead might prove a real challenge for investors in the sector, the team at JP Morgan has nominated four sector Top Picks: OZ Minerals, BlueScope Steel ((BSL)), IGO Ltd ((IGO)), and South32 ((S32)).

As Evolution Mining ((EVN)), equally post-shellacking, is now seen trading near five year-lows, this stock has become the broker's most preferred among gold producers.

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The upcoming results season won't simply be an extended line-up of negative corporate confessions, of course. There will be surprises to the upside. Plus some share prices will be seen as having fallen too far, even after releasing disappointing operational numbers.

A recent preview published by stockbroker Morgans on the local gaming sector singled out Jumbo Interactive ((JIN)) as one company that is likely to report strong growth numbers in August, followed by yet another year of strong growth in FY23. The analysts are equally positive about Tabcorp spin-off The Lottery Corp ((TLC)).

While noting Morgans' projections for Jumbo are slightly below market consensus, the company is the only one whose forecasts have not been downgraded ahead of August.

The other companies are BlueBet Holdings ((BBT)), Star Entertainment ((SGR)), Tabcorp Holdings ((TAH)) and The Lottery Corp, as well as Aristocrat Leisure ((ALL)) which does not report in August; the company only just released its six-monthly update in May.

Equally important: with the notable exception of Star Entertainment and Tabcorp, all four other companies are Buy-rated ('Add') at Morgans, with price targets that are double-digit percentages above present share prices (except for Tabcorp).

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One sector that remains on investors' radar are discretionary retailers. The Big Questions that to date remain unresolved:

-have share prices sunk too low?
-is it too early to expect the end of downgrades?
-what if next year proves The Bottom for this sector – how will investors respond in the meantime?

Similar to Morgans on gaming stocks, analysts at Jarden have cut their forecasts for ASX-listed discretionary retailers, many of those reductions are significant, in particular for FY23. But Jarden also suggests a general uptick in consumer confidence can translate into significantly less risk for the sector, which would make share prices look "cheap".

Judging from Jarden's revisions in forecasts, the news from upcoming results releases will look a lot less dire from household goods than from companies selling fashion or recreation goods.

Jarden has tried to apply multiple filters to identify which companies in the sector might be great value at present and its screens generated a positive outcome for Woolworths ((WOW)), Flight Centre ((FLT)), Domino's Pizza ((DMP)) and Accent Group ((AX1)).

Those that screened negatively: Harvey Norman ((HVN)), JB Hi-Fi ((JBH)), Nick Scali, Super Retail, and Beacon Lighting Group ((BLX)).

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These are but early attempts in what soon will become an avalanche in analyst updates and revisions ahead of and during the August reporting season in Australia, which is still 2-3 weeks away.

Meanwhile, another quarterly season of corporate reports is about to start in the US. Investors will be glued at their screens to find out whether, as just about everyone assumes, market forecasts need a significant re-set. For Australian investors, freshly emerging trends in the US might be translated onto the ASX.

One additional complication for US markets is the negative impact from a stronger US dollar. As pointed out by Morgan Stanley this week, a simple math on S&P500 earnings is that for every percentage point increase year-on-year, EPS growth is negatively impacted by 0.5x.

Given the USD is currently up by 16% year-on-year, this implies EPS in the US is facing a headwind of -8% just from the currency.

Therefore, concludes Morgan Stanley, the recent rally in stocks is likely to fizzle out before too long.

Reporting Season: Early Signals

The local reporting season hasn't genuinely started just yet, but early signals mimic initial reports from the Q3 reporting season over in the USA: investors should prepare for heavy swings either way.

One of the disappointing market updates in Australia stems from Jumbo Interactive ((JIN)) as the online reseller of lotteries was believed to be poised for a strong performance in August. Instead the share price got dumped on Friday. Higher costs and lower margin sales seem to have been responsible for the miss in guidance.

But there's a twist in the Jumbo story. With just about every analyst maintaining the longer-term, structural growth story remains intact, investors holding large swathes of cash would be hoping there will be more Jumbo experiences over the weeks ahead with companies that have their longer-term interest.

In the same vein, analysts thought Rio Tinto's ((RIO)) quarterly production report was weak and that share price would probably have fallen more on the day if it hadn't already weakened that much over the month past. Rio Tinto's weak quarter follows a number of soft updates and operational disappointments from smaller cap producers over recent weeks.

Credit Suisse, in its update on Sandfire Resources ((SFR)), highlighted a different kind of risk that resides within the smaller cap resources sector with the FNArena Broker Call Report stating on Friday:

"The broker raised concerns around Sandfire Resources's cash generation, and ability to service debt in the next 6-12 months, and believes the company is likely to suffer funding challenges if commodity prices continue to decline."

To stay with the swings and roundabouts narrative, a number of companies surprised in a positive sense throughout the week past, including Data#3 ((DTL)), Eager's Automotive ((APE)), Viva Energy ((VEA)), and WiseTech Global. Given where share prices are, generally speaking, those share prices are likely to be rewarded.

And herein lays the key challenge for investors over the coming six weeks: there will likely be an oversized number of disappointments, but not every "miss" is a bad thing. Similar to earlier in the year ahead of the February reporting season, everyone who owns shares must accept that "misses" will occur, and they are simply not always predictable.

Add the CEO suddenly jumping ship at EML Payments ((EML)) and ANZ Bank ((ANZ)) buying the banking operations from Suncorp Group ((SUN)) and there might be enough surprise and excitement on offer this season to keep even the most stoic among us on their toes.

A healthy dose of cash reduces risk and offers opportunity, as does patience. Meanwhile, the public debate -globally- rages on about recession yes/no and central bankers continuing to tighten aggressively yes/no.

Nobody ever promised this was going to be a walk in the park.

Corporate Earnings: Between Dr Jekyll & Mr Hyde

Viewed from afar, the upcoming results season in Australia will be rather unusual in that it might arrive too early in the down-cycle for investors to properly assess the resilience of a company's client base, profits and margins.

This is also the view of some commentators in the USA who believe the Q3 season over there might turn out only the first in a series of accumulating deterioration in company fundamentals.

Whereas an oft mentioned number, both here and in the USA, is -20% for corporate earnings, it's pretty much a given this is too large a reduction to be fully incorporated into updated forecasts throughout July and August. If -20% proves to be accurate, we won't know until much later, maybe as late as this time next year.

Confronted with this set-up, investors globally have not hesitated to de-risk their positioning, and to de-risk heavily. Shares in commodity producers, earlier in the year seen as the beez kneez when inflation-protection seemed on everybody's mind, have given up all their gains plus some over the seven weeks past.

Similarly, prices for gold, copper, oil, iron ore and the like have all declined over that period and most prices are now trading below analysts' forecasts, from a sizable premium previously, further adding downward pressure to consensus forecasts for corporate earnings.

As also illustrated by this month's quarterly production reports, many producers have found it difficult to meet guidance and/or expectations due to bad weather, staff absenteeism, rising costs and production shortfalls. The fact commodity prices are now in many cases below previous forecasts keeps the pressure to the downside, at least until the general mood towards the sector improves.

To illustrate how fast and how fierce the general de-rating has been for the ultra-cyclicals in the share market: the ASX200 Resources index was up nearly 25% in April, and more than 20% up by late May, but the index is now negative when measured from January 1.

The irony is that many in the local sector, be they BHP Group ((BHP)), Woodside Energy ((WDS)) or Whitehaven Coal ((WHC)), stand ready to pay out more dividends to shareholders than the banks or insurers, and with plenty of additional excess cash flows on top to have analysts speculating about share buybacks and special dividends forthcoming.

History shows there is no hiding in commodities leading up to an economic recession, and this time around many questions remain about what exactly China is up to. But a large number of investors has stayed true to their conviction that this time is different and selected commodities including coal, gas and lithium will prove resilient even in case of a recession because of specific supply limitations. 

Others might reason: who exactly is selling down a stock that has a prospective dividend yield of 42% and 31% respectively for this year and next, as is the case for Coronado Resources ((CRN))? But also: how long exactly can these shares stay at the current beaten-down level?

For what it's worth: some commodity analysts now believe the risk has shifted to the upside now that commodity prices and share prices have sharply corrected. A general view about only a mild recession coming next feeds into such optimism.

One of the local sectors that has disappointed investors since April are the ASX-listed gold producers. Not only has the narrative about buying gold as protection against inflation not held up this year (see link to video below), further adding to the general disappointment have been numerous profit warnings and sub-par production updates marred by rising costs and other headwinds.

Sector analysts at Ord Minnett, in a sector preview to August, believe this sector might not yet be done with issuing disappointing market updates. On Monday, with copper-gold producer OZ Minerals ((OZL)) yet again disappointing with lower revenues and higher costs, this prediction proved rather prescient indeed.

Note: OZ Minerals had already downgraded guidance in June and the share price had been shellacked in response, probably explaining why the punishment on Monday remained limited to circa -3%.

Ord Minnett believes market sentiment towards Australian gold producers is now "extremely low" but, reports the broker following a number of company visits throughout Australia, green shoots are emerging for the sector.

Ord Minnett suggests once forecasts have been re-based following the upcoming reporting season, there will be an opportunity to get on board as even the Quality names in the sector are trading at large valuation discounts.

Ord Minnett's sector favourites are Northern Star Resources ((NST)), Gold Road Resources ((GOR)), Silver Lake Resources ((SLR)) and Red 5 ((RED)) respectively for large-cap, mid-cap (2x) and small-cap exposure.

Another sector that looks poised for more disappointment in August are online consumer-oriented business models, in particular those which benefited from covid and lockdowns previously. Again, analysts will not accept these business models, carried by multi-year mega-trends, are now indefinitely ex-growth, but shorter-term more pain seems but logical.

Retailers and various other consumer-oriented companies have had it tough so far in 2022 as investors prepared for weakness in property prices putting pressure on household spending. Again, the August reporting season might come too early to properly assess the strengths and weaknesses for companies in this segment.

Shoe retailer Accent Group ((AX1)) issued a profit warning on Friday, showing investors' fears are not completely unfounded, and the share price got punished hard on the day despite already having halved since November last year. On Monday, buyers are moving in and the share price remains well-above its trough from June.

A positive signal for patient bargain hunters?

A similar observation can be made for Insurance Australia Group ((IAG)) whose shares are very much in demand on Monday, having sold off on Friday following yet another disappointing market update for which this insurer has accumulated a chequered track record.

There will always be investors who seek refuge in a share price that has fallen deeply enough, rather than owning shares in higher valued business models that are of a lesser risk of disappointing in August. It is but one reason as to why a season that will bring out the best and the worst out of ASX-listed companies, is poised to offer different opportunities to different types of investors.

Taking a general macro-view, earnings forecasts are now falling across the globe, but they have as yet not gone into negative territory. The implication here is that corporate profits might prove more resilient than those forecasting -20% decline are giving them credit for.

This is the optimistic view of global strategists at Citi who, despite preparing for economic recession, believe earnings forecasts most likely will surprise in a positive manner, which would also translate into less downside for equities in general.

Citi's optimism is consistent with in-house top-down modeling, which suggest 0-5% global EPS growth is possible for both 2022 and 2023.

Others are not as optimistic, with Macquarie, for instance, declaring equities in Australia or the USA look "cheap" when measured against historical PE multiples, but not when, as Macquarie strategists assume, corporate earnings might fall by up to -20% by this time next year.

Applying this rough assumption to current US forecasts, and multiplying by a recession-appropriate 16x multiple average, suggests to Macquarie the S&P500 might have to visit the 3300 level before resuming the next uptrend.

Others, like the strategy team at JP Morgan, believe that falling forecasts in 2022 are building the next platform from which equities can rally higher again, because lower forecasts are easier to beat and history shows equities trough well before the last earnings forecast cut has been put in place.

JP Morgan, too, believes weakness in corporate earnings should remain limited this year as nominal GDP in the USA, and elsewhere, remains positive.

On my personal observation, analysts in Australia have started reducing their profit projections, but more so for FY23 than for the current running year. This makes a lot of sense, also given most fiscal years end on June 30th in Australia. But what this also implies is that FY22 financial results are not the real story this August.

Share prices might still rally or sink following the release of FY22 financials, the further-out trajectory will likely be more closely linked to the changes in consensus forecasts in response to the release.

It might complicate matters just a tad more than usual this year (as a great FY22 result might still not prevent forecasts to be cut, and vice versa).

One final positive observation: the local share market's average dividend yield has climbed back to 5% on the back of lower share prices. I suspect many a local retiree will be very pleased about that.

Conviction Calls

Ord Minnett has used mid-year to nominate Top Picks and Least Preferred exposures.

For the local energy sector, the broker has nominated Woodside Energy ((WDS)) -Top Pick- and Worley ((WOR)).

For local consumer-oriented companies the nominations are Endeavour Group ((EDV)) -Top Pick- and Wesfarmers ((WES)).

In the healthcare sector, Top Pick is ResMed ((RMD)) while Integral Diagnostics ((IDX)) is considered a No-Go.

Among miners, the favouritism resides with South32 ((S32)) while Sandfire Resources ((SFR)) sits at the opposite end of the broker's sector ranking.

In the local REITs sector, Mirvac Group ((MGR)) is seen as the best buy, while GPT Group ((GPT)) is handed the wooden spoon.

Among diversified financials, Ord Minnett's favourite is AUB Group ((AUB)) while Least Preferred is Challenger ((CGF)).

The preference for AUB Group over Steadfast Group ((SDF)) seems to be related to the latter's recent outperformance and subsequently higher valuation.

(Most of the work done behind the scenes is by JP Morgan, with Ord Minnett white-labeling the research).

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Analysts at Morgan Stanley have started to communicate their highest confidence winners and (potential) losers from the upcoming August reporting season.

They find themselves in a bind when looking at Adore Beauty Group ((ABY)), strongly arguing the online beauty platform operator has a long-term promising future ahead, but shorter-term there could be disappointment lurking.

Headwinds are also there because twelve months ago this was one of the covid-beneficiaries, and that makes comparison this time around a tough hurdle to overcome.

Increased competition, margin pressure, tough comparisons with last year… enough to make Morgan Stanley nervous ahead of the upcoming FY22 release, to be expected in late August.

On the other hand, the broker is optimistic about Data#3 ((DTL)) with company management releasing a positive update recently. Morgan Stanley sees continued strong operational momentum.

What's quite astonishing about the Data#3 nomination is the broker officially only commenced coverage of the company less than a week earlier.

The same positive conviction applies to TPG Telecom-spin off Tuas Ltd ((TUA)) which is Morgan Stanley's preferred telco on the ASX.

Morgan Stanley is cautious on Dicker Data ((DDR)), short-term, because of supply chain risks. Longer-term there is no such caution as also proven by the broker's Overweight rating.

The highest concern ahead of August has been reserved for InvoCare ((IVC)) with Morgan Stanley analysts isolating multiple threats and risks for the funeral services operator.

One of the observations made is the company is no longer communicating its market share with investors; this is one metric that has not gone the company's way in recent years. Poor weather is likely to have impacted as well.

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Market strategists at Macquarie are still of the view that profit resilience needs to be sought after in the face of next year's economic slow down, with the potential for a global recession.

If we had to pick just one Outperform stock from each sector that has our confidence in likely earnings resilience during a period of recession, stated the strategists on Monday, they'd nominate the following:

-Steadfast Group
-Goodman Group
-The Lottery Corp ((TLC))
-TPG Telecom ((TPG))
-NextDC ((NXT))
-CSL ((CSL))
-Coles Group ((COL))
-Transurban Group ((TCL))
-Amcor ((AMC))
-Newcrest Mining ((NCM))
-Origin Energy ((ORG))

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Recent strategy update by Shaw and Partners:

"Borrowers should refrain from locking in longer term loan interest rates at prevailing levels as it is likely that the RBA will not raise rates as far as the market is currently pricing.

"Competition amongst lending institutions will continue to put downward pressure on net-interest-margins with positive implications for borrowers, but negative implications for banks.

"House prices are likely to continue to fall as rates rise, credit growth will slow from the current 9.2% level and bank share prices will struggle to move ahead."

And also:

"We maintain a defensive stance in multi-asset portfolios and await the slowdown in global growth and tightening of financial conditions to ease before becoming neutral and then constructive on growth assets."

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Morgan Stanley recently lined up seven reasons to Buy Top Pick Whitehaven Coal, irrespective of the coal miner's stellar run this year (still ongoing).

1. June-quarter production performance was strong
2. Legal proceedings regarding Narrabri Stage 3 extension can be conducted without significant production disruptions
3. FY23 free cash flow yield on the basis of current spot prices is simply enormous; 82% on Morgan Stanley's modeling
4. FY23 dividend forecast is, on the same basis, enormous too; 21% says Morgan Stanley
5. High spot prices make the current valuation look extremely cheap; FY23 EV/EBITDA is 0.2x on spot
6. The company's net cash is forecast to rise to $3bn in FY23, allowing optionality for significant capital management
7. Morgan Stanley rates the stock Overweight and lifted its price target to $8.50 from $7.75 (shares are at circa $6.16)

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Stockbroker Morgans' Core Model Portfolio has trimmed its exposure to Macquarie Group ((MQG)), as that stock had grown to an "excessive weight" in the Portfolio. Morgans is also expecting a lesser-year for the Golden Doughnut, while still expecting Macquarie remains a great holding for the longer-term.

Post share price weakness for BHP Group the Portfolio has bought extra shares in the Big Australian.

Morgans' Growth Model Portfolio has also sold some shares in Macquarie, for exact the same reason, while selling out of Megaport ((MP1)). The latter decision was made with pain in the heart, judging from the commentary explaining the move.

Morgans sees equally compelling opportunity among growth companies on the ASX that offer less risk and are of higher Quality. Currently on the Watchlist are:

-Seek ((SEK))
-REA Group ((REA))
-Domino's Pizza ((DMP))
-IDP Education ((IEL))
-Reliance Worldwide ((RWC))
-PWR Holdings ((PWH))

Additional commentary: "Feedback from our institutional clients suggests that many are now willing to dip their toes into the highest quality and oversold growth names among the small-mid caps."

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Strategy update by Wilsons:

"It may be the case that the market settles into a groove where the outperformance of the growth or value style is less marked than it has been in recent years.

"This has been the case in previous periods in history, implying that stock selection could trump investment style.

"To the extent that growth can regain its footing, quality growth is likely to be the way to go. We think it makes sense to invest in quality-focused portfolios that can weather a slower business cycle and cope with cost pressures.

"We retain exposure to all 3 investment styles –growth, value and quality – although our current style preference is quality."

August Preview: Curve Balls, Profits & Forecasts

If I were to put in my good-humoured attempt at an old fashioned Dad-joke, I'd start off with:

I am old enough to remember when corporate reporting season in Australia was all about profits, margins, dividends and forward-looking guidance.

It's not as if reporting seasons in the past have never been closely intertwined with macro-geopolitical, -financial or -economic concerns, but ever since the early days of the pandemic in 2020, corporate results season in Australia has never been simply about corporate health and profits.

If it wasn't about the virus, or societal lockdowns, the key drivers underneath share price trends have been the return of inflation followed by the normalisation in global bond yields.

The power of all four has proven extremely dominant throughout the past five results seasons and ahead of August, investor consensus is for a global recession on the horizon (domestic Australia not included).

We don't know yet about the exact timing or what will be the severity of the upcoming economic slump, but corporate results will definitely be assessed against the background of (much) tougher conditions ahead.

That is, unless central bankers declare the war on inflation is due for a pause and they stop their rigorous tightening, which adds yet another macro factor into the mix.

An end to the war in the Ukraine could be another macro catalyst, albeit an unlikely one.

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At face value, the Australian share market looks like a bargain hunter's paradise. The market's average Price-Earnings (PE) ratio starts with 13x while the average dividend yield has risen to 5% on the back of sharply weaker share prices for large segments of the ASX.

The long-term average PE in Australia is 14.9x including a few years of very high valuations. Prior to those years of elevated multiples, the average PE stood at 14.5x; still a long while off from today's multiple.

The problem with today's average is that commodity producers are enjoying exceptionally favourable conditions, to which investors have responded with low valuation multiples (as they traditionally tend to do when confronted with peak-of-the-cycle earnings and cash flows).

BHP Group ((BHP)) shares, for example, with circa 11% the largest index weight in Australia, are trading on 7x next year's forecast earnings per share. Shares in Rio Tinto ((RIO)) are on 7.3x. For Fortescue Metals ((FMG)) the comparable multiple is only 6.3x. The numbers look pretty similar for the large caps in the local energy sector.

Following the commodities resurgence post late-2020, mining and energy now represent the second largest group in the local index, after banks/financials.

Any experienced and astute investor knows such low PE multiples are not by default a signal of severe undervaluation; they are merely a sign that investors worry about the two years ahead. But having low PEs for such a large index constituent does depress the overall average, artificially creating the impression of a "cheaply" priced share market.

In the largest group, the banks are mostly trading on below-average multiples too; once again showing the market is concerned about RBA rate hikes, their impact on local housing and the subsequent impact on spending and the local economy in general.

Excluding the two largest index sectors, the average PE in Australia quickly rises above 20x, which, by contrast, still doesn't look that cheap at all.

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The biggest problem investors are facing today is figuring out what is the correct valuation for companies that mostly have no track record in dealing with an economic recession. For multiple reasons, the brief recession of 2020 is hardly a reliable reference point.

Not making things any easier, the impact of sharply higher bond yields, tighter liquidity and high inflation on economies and companies individually has been gradual, if not slow-paced thus far this year, while supply chain bottlenecks seem to be easing and lockdowns outside China are now a thing of the past, but the pandemic is not.

Combine all of the above and August seems too early to reveal the full impact for every company on the ASX.

With fast-moving share markets having de-rated large segments of the exchange, including retailers, small cap technology, building and construction materials, steel producers, gold miners, property trusts (REITs), mortgage brokers, et cetera one would be inclined to think the bias is leaning towards upside surprises this season.

The current pre-season has already provided a number of examples with explosive share price rallies in response. Think Audinate Group ((AD8)), Megaport ((MP1)), Nanosonics ((NAN)), and WiseTech Global ((WTC)), among numerous others.

However, the current set-up is by no means an invitation to go all-out on high risk positioning, with plenty of others generating steep losses, including Allegiance Coal ((AHQ)), Bega Cheese ((BGA)), Nitro Software ((NTO)) and just about every small and mid-cap gold producer out there.

At face value, corporate Australia looks positioned for an above-average performance this month. Profits for shareholders are projected to have grown by 20%-plus, while dividends are expected to come in near an all-time record high but recent caution by the board of Rio Tinto signals this year's numbers are best not taken for granted.

Similar caution is already reflected in today's consensus forecasts which, mostly, reflect the view commodity producers have at best one more year of 'exceptional' in front of them. Forecasts do differ as to how favourable exactly the coming twelve months might still turn out for BHP, Woodside & Co but FY24 has negative growth penciled in.

The dilemma as how best to position for the upcoming economic recession yes/no, this year/next year, mild/more severe is not limited to miners and oil and gas producers, but easily extends to local retailers, both bricks and mortar and 100% online.

Judging from recent market updates by JB Hi-Fi ((JBH)) and Accent Group ((AX1)) the day-to-day dynamics for these companies vary widely even without much of a noticeable correction in house prices as is now widely assumed to happen over the 18 months ahead.

Investors should also note: while dividend payouts are anticipated to remain strong, total payouts in Australia are highly concentrated with the big four banks and big three miners representing 60% of the total forecast FY22 dividend payout.

Current market estimates are for significantly lower EPS growth in FY23 and FY24, with the number for each year in single digit, and with more downgrades yet to follow.

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While just about everyone expects to see net downgrades to growth forecasts over the weeks ahead, there's plenty of disagreement on the magnitude of what should be expected, and priced in, in terms of slower growth in FY23.

Analysts at Citi, for example, expect economic recession in all of the major economic regions of the UK, Europe and the USA (with China to miss its own target), but they also expect corporate profits to prove relatively resilient, which should reduce further downside potential for equity markets worldwide.

Their peers at Macquarie, however, continue to see (a lot) more downside, but they also anticipate a stronger-for-longer environment for the cyclical commodities.

Not all answers will be provided through company performances this month. But one observation stands: research analysts have been showing their short-term scepticism throughout June and July in responses to corporate market updates that can probably be best summarised as:

Okay for now, but what does it look like in 6-12 months' time?

I suspect the same question will be on institutional investors' mind throughout the August season.

Which is why I suspect many share prices will not necessarily follow through on early positive responses to better-than-expected performances. Whereas the past suggests better-than-forecast corporate results can support share price outperformance for up to four months, this time around the dynamic might be fundamentally different.

The difference comes down to that key question: how resilient are these profits and margins under rough weather?

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The oft mentioned credo is that, ultimately, share markets take their guidance from, and follow in the footsteps of corporate profits.

This is only half true, at best.

In practice, share markets move in the direction of where forecasts of corporate profits are pointing towards. The two are not by default the same. This is why, on occasion, macro considerations overwhelm bottom-up reality.

By mid-2022, market forecasts have now started to fall in Europe, the US and locally in Australia too.

For the US specifically, media and commentators steadfastly mention percentages of "beats" and "misses" but the real statistic to pay attention to is how corporate results impact on analysts' forecasts post the event.

On Macquarie's observations, Q2's share of "misses" from US result releases is currently 4x higher than in Q2 last year and double the percentage in Q1, with downgrades to forecasts outnumbering upgrades by 2 to 1.

Plus more than half (56%) of S&P500 companies missed analyst expectations on free cash flow; the number of misses rises to 59% for operating cash flow.

Free cash flow, points out Macquarie, is an important, big "miss" given valuations in the US are more closely tied in with cash flows than they are in Australia.

Macquarie's notes might prove important later in the year as some of the more downbeat forecasters (Mike Wilson at Morgan Stanley, David Rosenberg, et al) consider the Q2 reporting season in the US as simply the first in a succession of disappointing quarterly seasons.

Macquarie also notes 47% of S&P500 results to date have revealed higher-than-expected inventories.

In Europe, businesses are on average beating forecasts for sales, but triggering downgrades because of margin pressure.

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As things stand at the beginning of August, analysts' forecasts are lowest for your typical retailer, with negative profit growth only followed by (on average) marginal growth in the two years ahead. Food and Staples companies are projected to fare much better.

Healthcare is expected to be its historically resilient self, but internally a wide diversion has opened up between, say, CSL ((CSL)), ResMed ((RMD)) and Pro Medicus ((PME)) on the positive side and Integral Diagnostics ((IDX)), Healius ((HLS)) and Sonic Healthcare ((SHL)) in (anticipated) struggle street.

In between sits perennial promise Ramsay Health Care ((RHC)), also constantly under private equity interest.

A big year is projected for insurers in FY23, whereas diversified financials, which includes local asset managers, carry very low expectations. Real estate looks similar to healthcare: resilient as a sector, with large divergence internally.

Technology, believe it or not, is expected to continue to generate robust growth numbers in August and the years ahead, but probably needless to make the point: this sector is beset with all kinds of variaties, ranging from very high but slowing (WiseTech Global) to reliably consistent (TechnologyOne ((TNE)), to long-term potential with risk and question marks (Megaport) and not-sure-what-to-believe-anymore (Damstra Holdings ((DTC)).

Somewhere in between sits the currently very popular Audinate Group.

As far as the banks are concerned, nothing spectacular is expected with the debate raging about how much benefit exactly will flow through to the bottom line from a higher cash rate and how much impact should be accounted for when property dynamics change for the worse, even if only for a limited time?

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Companies expected to surprise positively, on Citi's assessment, include Bapcor ((BAP)), Baby Bunting ((BBN)), Coles Group ((COL)), Goodman Group ((GMG)), Harvey Norman ((HVN)), Orora ((ORA)), and Woolworths ((WOW)).

Quant analysts at Morgan Stanley have selected Medibank Private ((MPL)), Whitehaven Coal ((WHC)), The Lottery Company ((TLC)), QBE Insurance ((QBE)), Ampol ((ALD)), Downer EDI ((DOW)), Worley ((WOR)), Challenger ((CGF)), ASX ((ASX)), Atlas Arteria ((ALX)), Bendigo and Adelaide Bank ((BEN)), Orora, Qube Holdings ((QUB)), Altium ((ALU)), and Computershare ((CPU)).

Morgan Stanley's quant selection for likely disappointment might contain a few surprises: Charter Hall Group ((CHC)), Evolution Mining ((EVN)), AGL Energy ((AGL)), Allkem ((AKE)), OZ Minerals ((OZL)), BHP Group, Reece ((REH)), Cochlear ((COH)), GPT Group ((GPT)), REA Group ((REA)), Iluka Resources ((ILU)), Mirvac Group ((MGR)), Origin Energy ((ORG)), Lendlease ((LLC)), and CommBank ((CBA)).

Also noteworthy: struggling Magellan Financial Group ((MFG)) still ranks as a likely disappointment among ASX small caps this month on Morgan Stanley's quant analysis, alongside Healius, Integral Diagnostics, Platinum Asset Management ((PTM)), and Sims ((SGM)).

On the broker's fundamental research desk, Magellan remains the least preferred in the local sector which, all il all, is not considered attractive or full of potential. A recent sector update by Morgan Stanley was titled "No Way Home" and lamented the lack of obvious catalysts for a local sector that is struggling with funds outflows.

Morgan Stanley likes Perpetual ((PPT)) the most, as well as, on a broader asset definition, Macquarie Group ((MQG)).

Following on from growing risks with inventories in the US, Macquarie has identified City Chic Collective ((CCX)) and Breville Group ((BRG)) as potentially carrying the highest inventory risk on the ASX.

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JP Morgan sees stabilising bond yields providing support for local REITs which are expected to report extremely strong growth this month (18% on average).

While the sector will be facing asset devaluations instead of revaluations going forward, JP Morgan continues to see great value in the sector.

The broker's top favourites are Mirvac Group, Charter Hall, Scentre Group ((SCG)), and Dexus ((DXS)), as well as smaller-caps National Storage ((NSR)), Centuria Industrial REIT ((CIP)), Centuria Capital Group ((CNI)), HomeCo Daily Needs REIT ((HDN)), Waypoint REIT ((WPR)), Home Consortium ((HMC)), and Hotel Property Investments ((HPI)).

Scentre Group, Charter Hall and National Storage in particular have been singled out for strong earnings deliverance this month.

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Similar to the retailers, Macquarie's forecast is most media companies will still report robust performances in August, but it'll only be a matter of time, predict the sector analysts, before a slow down in advertising will make its mark across the sector.

Macquarie's sector favourites are Carsales ((CAR)) and HT&E ((HT1)) while both Seven West Media ((SWM)) and Nine Entertainment ((NEC)) might surprise through capital management.

Macquarie forecasts the bottom for media companies' share prices is 6-12 months into the future.

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Recent research updates have become noticeably less optimistic on international travel and higher-for-longer oil prices.

Self-declared oil bears at Citi, for example, are now working off average Brent oil price forecasts of US$98.5/bbl and US$75.3/bbl for 2022 and 2023 and by 2025 the low is projected at US$51/bbl.

Conviction Calls

Morgan Stanley has highlighted Baby Bunting ((BBN)) as one small cap retailer that is poised for outperformance this August reporting season.

Further supporting their confidence, the analysts state Baby Bunting has one of the strongest competitive positions of any Australian small cap retailer in terms of relative scale, brand, loyalty on top of a genuine omni-channel offering.

When it comes to small cap Software-as-a-Service (SaaS) companies, Morgan Stanley's Top Pick on the ASX is Bigtincan Holdings ((BTH)).

For previous pre-August nominations: see last week's Weekly Insights:

https://www.fnarena.com/index.php/2022/07/28/rudis-view-im-so-bearish-im-bullish/

Morgan Stanley also issued a special 3 Conviction Buy Ideas report which specifically highlighted CSL, Telstra ((TLS)) and Breville Group.

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This week's update on stockbroker Morgans' Best Ideas saw the inclusion of Jumbo Interactive ((JIN)), likely inspired by recent share price weakness, and the removal of Endeavour Group ((EDV)), Baby Bunting (yep, see the contrast with above), Domino's Pizza ((DMP)), and Whitehaven Coal ((WHC)).

No shortage in Best Buy ideas with Morgans' selection currently counting 33 ASX-listed companies, including Wesfarmers ((WES)), Macquarie Group, GQG Partners ((GQG)), Dalrymple Bay Infrastructure ((DBI)), Lovisa Holdings ((LOV)), Mach7 Technologies ((M7T)), Treasury Wine Estates ((TWE)), Incitec Pivot ((IPL)), Webjet ((WEB)), BHP Group, South32 ((S32)), Dexus Industria REIT ((DXI)), and HomeCo Daily Needs REIT ((HDN)).

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With A-REITs increasingly on investors' radar in recent weeks, sector research by Barrenjoey has reportedly highlighted above average risks from higher bond yields which lift the costs for carrying and servicing debt.

Those identified as most vulnerable include GPT ((GPT)), Centuria Industrial REIT ((CIP)), Charter Hall Long WALE REIT ((CLW)), Dexus ((DXS)), and Shopping Centres Australasia Property ((SCP)).

In addition, and assuming property prices are now staring at a -15%-20% decline in valuations over the next 18 months or so, the research also highlighted higher risks for Mirvac Group, Stockland ((SGP)) and Lendlease.

Focus On Quality

The debate is still raging whether Growth can make a sustainable come-back or whether Value remains the best strategy-tilt even when history shows recessions are not really kind to cyclical companies.

Enter a third option: sturdy, reliable businesses that power on, regardless of economic cycles and conditions. It's the Quality way and market strategists at Wilsons dedicated their latest report on why a focus on Quality makes a lot of sense today.

This quote that says it all:

"We expect global economic growth and earnings growth to slow significantly over the coming year. As a result, companies with high quality, resilient earnings streams should be increasingly sought after by the market."

Apart from taking a peak at FNArena's dedicated All-Weather Performers section (for paying subscribers only), how does one identify true Quality companies?

Wilsons offers a few key characteristics:

-High return on equity (ROE) or high return on invested capital (ROIC)

-Low variability in annual earnings

-Strong balance sheets with modest gearing

Plus investors can throw in an extra factor in the form of, for example, quality of management and/or industry leadership.

Additional quality attributes can include strong generation of free cash flow and high operating margins.

Wilsons does observe Quality has underperformed over the past two years as first high multiple stocks got exuberantly priced, then de-rated and earlier this year the energy sector outperformed strongly.

But with earnings slowing and more downgrades than upgrades on the agenda, the view is that resilient, high-quality companies look poised to grab market leadership once again.

All-Weather Performers: https://www.fnarena.com/index.php/analysis-data/all-weather-stocks/

August Results: First Blood

The August corporate results season is officially more than one week old, but the FNArena Monitor still only contains 11 updates. A lack of sufficient qualified accountants, apparently, pushes the bulk of corporate releases in Australia into the final two weeks of the month.

But the opening salvo this year, including the preceding fourth quarter updates by miners and energy producers, has already provided some valuable insights which might prove prescient of what is yet to be unveiled over the coming three weeks.

So let's start with some of the insights that should come in handy as Australian investors prepare for the seasonal tsunami in corporate updates.

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Members of the Australian Shareholders Association (ASA) in Busselton, WA ^(*) looked a bit puzzled when I told them in May this year: you do realise that producers of copper, gold, oil & gas, and other commodities are themselves heavy consumers of diesel, steel, water, power, and other commodities?

That reality soon started to show up in quarterly production updates from miners and energy producers. And one sector on the ASX that has been heavily hit are the local gold producers, if only because gold has largely traded sideways this year, apart from a temporary spike as Putin's army crossed the border with the Ukraine.

Rising costs when the price of your main output refuses to spike higher can only mean one thing: margin pressure, and lower profits.

Post-April, the sector has had a rough time. While the return of market optimism in July has seen many share prices rallying off their lows, most prices are still nowhere near the levels witnessed earlier this year. Shares in Newcrest Mining ((NCM)), by far the largest producer in this country, are still trading some -35% below their $29-peak in April.

And so it was, when sector analysts at Canaccord Genuity updated their modeling and forecasts at the end of July, a lot needed to be accounted for as higher costs translate into higher investments for those companies looking to expand and into higher operational expenses when running daily operations.

Consider the following incomplete list of price increases the industry is dealing with:

-Diesel costs up 60% on average in WA
-Steel prices are up 60% from one year ago
-Freight costs can be up to 400% higher
-Costs for drilling have increased by 15-20% in recent months

No surprise thus, running higher operational costs and capex estimates through its modeling, Canaccord Genuity's valuations reduced by -24% on average for explorers and developers and by -26% for producers.

The Canadian firm specialises in small and micro-cap companies in Australia. When peers at UBS reviewed the sector last week, the average damage was a lot smaller as UBS restricts its research and coverage to larger-cap producers. But with no sustainable uptrend predicted for the price of bullion (not anytime soon), the underlying conclusion is pretty much the same:

"…tempered growth ambitions, continued operating and inflation headwinds combined with our reduced price deck means stocks are not as cheap as they look."

Make no mistake, amidst universal, broad-based sector weakness, there are always opportunities for investors, and both teams of sector analysts have their favourites, but the real message seems to be: rigid selection is key.

Not every share price that has fallen represents a great opportunity for mid- to longer-term investing. The challenge for investors is to identify the real gems and the real quality in a basket that is full of pretenders.

For what it's worth, UBS's favourites are Northern Star Resources ((NST)) among the large caps, because of the company's strong organic growth pipeline, and Gold Road Resources ((GOR)) among small caps. UBS analysts advise investors should focus on strong balance sheets, low risk growth and newer mines with a good runway and optionality still ahead.

Canaccord Genuity's sector favourites are Bellevue Gold ((BGL)), De Grey Mining ((DEG)) and Predictive Discovery ((PDI)). All three have rallied off their June-July low.

Macquarie's favourites are Northern Star, Silverlake Resources ((SLR)) and Gold Road Resources among producers, as well as Bellevue Gold and De Grey Mining among juniors in the sector.

Says Macquarie:

"Though sequentially softer gasoline prices should take some sting out of headline inflation, underlying inflationary pressures continue to broaden and momentum in core services prices does not yet show any sign of letting up."

As well as:

"We think it premature for the market to be anticipating a Fed pivot."

The latter suggests those 20%-plus share price moves for the likes of St Barbara ((SBM)), Bellevue Gold, Resolute Mining ((RSG)) and Regis Resources ((RRL)) might look premature once the market's focus changes back to on-the-ground dynamics and a likely persistence by the Fed to tame inflation with aggressive rate hikes.

It goes without saying, the cost-inflationary pressures that have dogged the gold sector this year equally apply for commodity producers elsewhere, as also shown by June-quarter trading updates released by sector heavyweights BHP Group ((BHP)) and Rio Tinto ((RIO)), as well as by the half-year report already released by the latter.

The one commodity producer that also released financial results, other than Rio Tinto, Canadian iron ore producer Champion Iron ((CIA)) equally disappointed last week, and higher-than-anticipated costs proved one important contributor. Its share price weakened some -45% since the beginning of April, and has staged a mini-rally in August after initially selling off on the quarterly financials.

OZ Minerals ((OZL)) -more copper than gold- equally disappointed with its quarterly update in July, but the share price recovered ahead of BHP Group launching an unsollicited, "opportunistic" take-over bid for the company on Monday. Completely predictable, the news has reinvigorated momentum in share prices for other copper/gold producers such as Sandfire Resources ((SFR)) and 29Metals ((29M)).

Combine all of the above and the take-away message for investors might be that sharply weaker share prices may have already discounted a lot of the bad news, at least in the short term, but cost inflation remains a problem and is creating wide divergences inside sectors. As far as OZ Minerals goes: this company is widely seen as a quality operator. Probably no coincidence then it has been on BHP's radar, instead of other, more cheaply priced, lesser quality alternatives?

BHP's take-over attempt also shows August this year won't just be about bottom line-financials and forward looking guidance. Analysts are expecting at least some commentary about a bonus dividend from Woodside Energy ((WDS)), while Origin Energy ((ORG)) should continue its share buyback.

Woodside is also still looking to sell down its Scarborough project, while Santos ((STO)) might soon announce new ownership for its non-core asset in Alaska, and potentially for its equity in PNG LNG too.

Note to us all: the threat of economic recession has not dissipated. The odds are actually shortening that Europe and the USA will join the UK in the months ahead.

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Another sector that has equally landed under close scrutiny are local real estate investment trusts, A-REITs.

The early part of the earnings season saw both Centuria Industrial REIT ((CIP)) and Centuria Offce REIT ((COF)) releasing FY22 financials and while the former met forecasts and offers optimism now the share price has weakened significantly year-to-date, the latter disappointed and sees investors and sector analysts continuing to adopt a more cautious approach.

What both REITs have in common is management at each trust has adopted a cautious approach regarding the rising cost of debt, which could become somewhat of a sword of Damocles hanging over this sector for the year(s) ahead.

In simple terms, the market has taken what seems a rather dire view as to how high the weighted average cost of debt (WACD) can rise up to over the coming three years. While more optimistic sector analysts can thus see "value" in the sector, others think the market's pricing seems but a realistic scenario.

The underlying sentiment seems similar as with gold miners and commodity producers in general: not every weakened share price is offering a great opportunity; it remains necessary to distinguish the wheat from the chaff.

The real estate analyst at Barrenjoey, Ben Brayshaw, is among the least enthusiastic. He thinks REITs will meet FY22 forecasts in August, but the outlook is for reduced growth, reduced profits, and reduced payouts for the sector on average. Issues range from rising costs, to deflating property markets, to the threat of less consumer spending, to still struggling office assets, to less opportunities for acquisitions, to higher headwinds from servicing debt.

Regarding the latter, Barrenjoey points out those REITs carrying the highest debt costs in Australia include GPT ((GPT)), Centuria Industrial REIT, Charter Hall Long WALE REIT ((CLW)), Dexus ((DXS)), Shopping Centres Australasia ((SCP)), Charter Hall Social Infrastructure REIT ((CQE)), and HomeCo Daily Needs REIT ((HDN)).

In addition, Barrenjoey is cautious on the FY23 outlook for Mirvac Group ((MGR)) and Stockland ((SGP)).

REITs were firmly in focus throughout week one, with Bunnings landlord BWP Trust ((BWP)) mid-week reporting "strong fundamental performance" and "prudent positioning", but given BWP just about always trades at a sizeable premium versus the rest of the sector, analysts simply cannot get excited, and this includes the perceived risk-profile for the trust.

Here one of the most interesting pieces of analysis has been released by Citi which has attempted to rank the local sector in accordance with a lower-than-average or above-average risk profile. Turns out, BWP Trust is one of the least risky options among local REITs, at least on Citi's assessment.

Scentre Group ((SCG)), Charter Hall Social Infrastructure REIT, Shopping Centres Australasia, and Charter Hall Long WALE REIT have been ranked near the upper side of the risk ladder, echoing similar comments published by peers elsewhere.

There's one thing all sector analysts seem to agree upon, and that is that sector leader Goodman Group ((GMG)) is in great condition, is most likely to continue reporting admirable financials and growth, and, on Citi's ranking, represents the lowest risk profile among peers in Australia. Even Barrenjoey's Brayshaw agrees on this.

The offsetts include a premium valuation (which is easily explainable through Citi's assessment), constant calls the stock looks overvalued by your typical value-investor, and a non-attractive dividend yield of circa 1.6% – a direct consequence of having been accepted as a premium, quality operator in recent years.

The sector as a whole is often described as a beneficiary of higher inflation, but the first three financial results this season have already proved this narrative is too simplistic for general purpose.

Already, though, there is an underlying sentiment that genuine quality will reveal itself this month, and I like to think this won't be limited to REITs.

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The first week also saw two asset managers releasing FY22 results and the outcome could hardly have been more different.

In one corner we find Janus Henderson ((JHG)), struggling, and struggling heavily to keep investor funds from departing while share markets in general are likely to face ongoing subdued momentum as the threat of economic recession continues to loom large.

In the other corner sits Pinnacle Investment Management ((PNI)), the umbrella group that includes affiliates such as Firetrail Investments, Hyperion Asset Management, Metrics, Plato Investment Management and Solaris. Readers might recognise a few of the very active advertisers and sponsors behind industry events.

Clearly, Pinnacle is enjoying much more popularity than its peers this year, making the impact from sector-wide selling on its share price pre-FY22 release looking extremely silly. But as everyone can see from the price chart, the market has not hesitated to correct that situation in a heartbeat.

Maybe the take-away message here is that individual strength can overcome general sector malaise.

The stand-out observation is that just about every analyst thinks local asset managers remain poised for continuing rough times, with the possible exception of a few, including Perpetual ((PPT)), Pinnacle and Navigator Global Investments ((NGI)). The latter, however, has never been fully embraced by local investors since its listing on the ASX pre-GFC.

Just about everyone is looking for more bad news from fallen angel Magellan Financial ((MFG)).

When Forecasts Are Too High

One conclusion to draw from the first two weeks of the August corporate results season in Australia is some share prices had been sold down too deeply earlier in the year.

Take BlueScope Steel ((BSL)), for example. On Monday, the company released a better-than-forecast FY22 performance, but guidance for the six months ahead will force most analysts to lower their estimates. Yet post-result, the shares have quickly gained more than 5%.

BlueScope also announced an extra $150m will be added to the running share buyback, hereby extended, which could be a positively contributing factor as well.

Irrespectively, the shares were trading near $26 exactly one year ago and they fell as low as $15, a few times, in July.

FNArena's consensus target is currently sitting underneath $22, implying there's a whole lot more upside potential remaining, on condition that sentiment doesn't sour on the prospect of an economic recession in the year ahead.

On Monday, financial result releases by Carsales ((CAR)) and GPT Group ((GPT)) have equally triggered a notable positive share price response.

But let's not get carried away, Bendigo and Adelaide Bank ((BEN)) reported as well, and its shares are, at the time of writing, down some -8.6% while Beach Energy's ((BPT)) update has seen its shares tank by -12.4%.

It's still very much a heavily polarised market and share price responses in either direction are not confined to your traditional definitions of 'value', 'growth', 'defensive' or 'quality'; not even to 'cheap' or (seemingly) 'expensive'.

Shares in GUD Holdings ((GUD)) have been trading well, well below most price targets set by stockbroking analysts, yet there is no visible momentum whatsoever post the release of FY22 financials.

On initial assessment, it seems GUD slightly missed expectations, with no forward guidance provided.

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The August corporate reporting season is now mid-month in Australia, but in terms of actual numbers the harvest to date is still tiny. FNArena's Monitor (updated daily) still only has 39 results and we are expecting that number to grow to 350 by the first week of September.

I am not trying to be the early party-pooper, but there hasn't been much as yet to draw a lot of positive inspiration from.

Up until a few years ago, reporting seasons used to take off with a number of positive results, but this year's early-season sentiment boost clearly has to come from the likes of BlueScope Steel: companies whose share price has been pulled down too far.

In terms of released results to date, the FNArena Monitor has 46% (18) as reporting in line with forecasts, with beats (11) and misses (10) pretty much on an even keel.

Too early to draw any firm conclusions, though it is my personal view that we have been rather positively-biased when registering Rio Tinto's ((RIO)) result as "in line" and Telstra's ((TLS)) as a "beat" – both could just as easily be called a "miss" and "in line" respectively, which would have tilted the early season numbers towards a negative start.

One added observation is this year's challenging environment is proving more challenging for the weaker operators and for the sector laggards than it is for the leaders, as one might expect.

In other words: it should not surprise market updates by 'Bendalaide' Bank and Westpac ((WBC)) are not of the same robust nature as the updates released by National Australia Bank ((NAB)) and CommBank ((CBA)).

Another observation is that certain perennial underperformers simply find themselves supported by favourable macro-momentum, which helps with glossing over yet another wishy-washy market update.

Insurance Australia Group ((IAG)) comes to mind, though fellow insurers QBE Insurance ((QBE)) and Suncorp Group ((SUN)) didn't exactly exhibit a lot of inherent strength either.

Those analysts retaining a positive view do so predominantly on the insurance cycle, which is thought to be positive for the year ahead. Share price action post-results for these insurers has not been inspiring, to put it mildly.

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UBS strategist Richard Schellbach is more optimistic. He sees early indications of corporate Australia proving more resilient than the sceptics are forecasting. Market updates by the major banks are one prime example of this thesis.

Of course, the obvious contra-comment to make here is the true impact from RBA tightening has yet to be felt and CBA head honcho Matt Comyn, for one, is preparing for a rough twelve months ahead.

To Schellbach's credit, confession season has been fairly mild prior to August and most companies, though they may not inspire higher forecasts or increased enthusiasm, they are still predominantly performing in line with guidance and market expectations.

As expected, analysts are busy downgrading forecasts for the year ahead; a process that already started in the months leading up to August. Schellbach predicts such downgrades are likely to persist over the next six months.

Traditionally, and all else remaining equal, this would form an extra headwind for the market in the coming months.

Market strategists at Macquarie are equally positive after the first two weeks of corporate financials in Australia, noting large caps and financials in particular have managed to generate more positive earnings surprises while free cash flow has generally been better-than-forecast.

Macquarie does acknowledge the low sample to date, plus the fact discretionary retailers and industrial companies have yet to report in large numbers. Inventories could be the extra sting on top of rising costs.

Macquarie also observes 35% of reporting companies to date has guided to growth below 6% in the year ahead. This, the broker highlights, would be below inflation if its own inflation projection for 2023 comes to pass.

One early observation worth highlighting is Macquarie pointing out stocks with high short interest have thus far experienced the best post-result returns.

In contrast to its early reporting season assessment, Macquarie doesn't like the market's set-up with valuations considered high, in particular if that US recession arrives next year, as is the broker's in-house prediction.

Macquarie thinks a lot more downgrades will be needed to pull profit forecasts in line with next year's reality on the ground.

The combination of still-high valuations and forecasts cum further downgrades elicits a rhetorical question from Macquarie: how can this be a new bull market?

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Even more worried than Macquarie about analysts' too rosy forecasts is the team of US strategists at Citi.

On their observation, present bullishness in analysts' forecasts globally has only been matched twice; in 2000 and in 2007. Of course, we all know what subsequently happened; a big bear market opened up and share markets halved in value.

Citi runs a regularly updated Bear Market Checklist, with the strategists explaining this is exactly why (too) bullish analysts forecasts are one of the warning signals on the checklist.

The discrepancy between top-down forecasters and the bottom-up projections by analysts could hardly be more different: the first group is seeing ever more signs of recession ahead, but there's currently no room for such economic contraction in bottom-up forecasts.

Just to be sure: peak bullishness in forecasts does not by default mean share prices will halve in the months ahead. Citi's historical data going back to 1994 shows one other example: 2010-2012. Back then, remind Citi strategists, peak bullishness proved a false signal. Global equities merely traded sideways over the following 12 months.

How do we explain this wide divergence and why is it that bottom-up forecasts are the ones most likely out of sync with reality?

From Citi's report:

"Notably, analysts get the beginning of bear markets very wrong. Instead of turning cautious, they turn even more bullish.

"Even though they are starting to revise down earnings forecasts, falling share prices and cheapening valuations keep them positive.

"They do eventually turn more cautious as earnings forecasts fall further, but it is a slow process."

Here's the official warning:

"With prices falling further than EPS downgrades, PE multiples are contracting.

"Surely the bad news is already priced in?

"History suggests that investors should be wary of following this logic."

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Citi's assessment, albeit global, receives two thumbs up from Credit Suisse's in-house assessment of financial conditions in Australia. The RBA's tightening thus far in 2023, explains Credit Suisse, has already amounted to one of the fastest periods of financial tightening for the country.

Now for the bad news (supporting the views of UBS, Macquarie and Citi): history shows financial tightening precedes actual GDP by two quarters, or half a year. This signals domestic GDP in Australia will shrink to below 2% growth by early 2023, and thus forecasts for corporate profits will prove too high.

Credit Suisse estimates the risk to corporate profits in Australia is circa -15% over calendar year 2023. The broker also thinks the RBA is ready to turn more dovish in Q4, which will provide market support when analysts should be busy further reducing forecasts.

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FNArena is in the unique position of having our own data, and history going back to early 2006, which allows us to check data assessments such as the one highlighted by Citi.

On FNArena's Buy-Hold-Sell data, the percentage of Buy (and equivalent) ratings in Australia has seldom been as high as this year, which is one reason as to why I personally have been warning about a bear market this year.

As also expected, with more than 59% in positive ratings, local analysts are issuing more downgrades than upgrades, with downward adjustments to valuations outnumbering increases, as underlying growth projections are coming under pressure.

I can confirm Citi's general observation: these are slow-paced processes. Analysts are using the relative resilience in FY22 performances as a general sign to go slowly on paring back next year's numbers, also supported by relatively upbeat comments from management teams at companies.

While none of these statistics tells us anything about the likely trend in markets in the days, weeks, or even months ahead, they do raise serious questions about today's valuations and calls for a new bull market having commenced.

As per always, successful investing is not about constantly making accurate forecasts. It's about making sure that if a forecast proves wrong, you're not losing shirt and trousers in the process.

August Delivering More Downgrades And Misses

As far as price action goes, any company that disappoints this season is likely to see its share price drop for more than one day, even if that initial punishment on the day looks like a genuine shellacking.

Think Redbubble ((RBL)), down nearly -40% over the four days following its FY22 update, but also Blackmores ((BKL)), Codan ((CDA)), Inghams Group ((ING)), the ASX ((ASX)), Appen ((APX)), Pact Group ((PGH)), Australian Clinical Labs ((ACL)), TPG Telecom ((TPG)), and numerous others.

That's the 'normal' part of the August reporting season thus far. Thou shalt not disappoint remains an all-important condition in any reporting season.

But we also have two notable exceptions this month, and they are worth highlighting.

First category: share prices that had been sold down too far, irrespective of further disappointing news.

Second category: excellent performances that won't be rewarded post the initial on-the-day rally, because the market doesn't believe it is representative of what earnings might look like when tougher times arrive next year.

Plenty of examples fit in to category two and most have one or two things in common: they are either retailers (dependent on consumer spending) and/or exposed to the local housing cycle. JB Hi-Fi ((JBH)), Super Retail ((SUL)) and Stockland Group ((SGP)) are a few examples that come to mind.

Share price action post recent disappointing market updates suggests a lot of negative news had already been accounted for in prices for Auckland International Airport ((AIA)), BlueScope Steel ((BSL)), Challenger ((CGF)), Fisher and Paykel Healthcare ((FPH)), and GUD Holdings ((GUD)).

James Hardie ((JHX)) did issue a profit warning, but every analyst covering the company had already anticipated it.

Larger-sized companies are usually more resilient than small-caps and the first three weeks have delivered some notable heavy punishments for Redbubble and the like, confirming the thesis. Even though, it has to be noted, Adbri ((ABC)) shares are down -17% on the day of this company missing market expectations.

Even more important, potentially, is the fact that outperforming market forecasts with June-half performance and forward guidance is proving a bridge too far for most ASX-listed companies.

Having judged 120 corporate releases as at Monday, August 22nd, the FNArena Corporate Monitor is witnessing an ever widening gap between "misses" and "beats", currently at 32.5% (39) versus 25% (30).

Given the exceptionally high percentage in Buy ratings at the start of this season, it should not surprise downgrades are significantly outnumbering upgrades; 42 against 12 on Monday, while price targets are either falling or not adding much. Virtually every market update is followed-up with reduced forecasts for the year ahead.

With around two-third of companies yet to report, investors might want to keep their fingers crossed there is improvement on the horizon.

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Against the background of more "misses" than "beats" and analysts cutting forecasts for FY23, Ord Minnett head of private client research, Simon Kent-Jones has observed how companies that are able to provide shareholders with a positive outlook are being rewarded through a favourable share price response.

Kent-Jones refers to Brambles ((BXB)), Medibank Private ((MPL)) and Treasury Wine Estates ((TWE)) but equally to positive dividend announcements made by the likes of BHP Group ((BHP)) and Telstra ((TLS)).

On the broker's assessment, all these share prices have outperformed the broader market thus far in August.

Over at UBS, strategist Richard Schellbach and analyst Akash Biradar, also zoom in on the positives so far, and this includes corporate Australia overwhelmingly posting robust, resilient financial performances this month, on average outperforming analysts' forecasts.

The flipside is, of course, that most of the disappointments do not come through FY22 financials, but via cautious, if not absent, forward indicators and guidance.

The UBS duo does concede this picture of relatively robust operational financials might yet be put to the test in the final stage of this season when more domestic and consumer related companies release market updates.

Meanwhile, there is no escaping, earnings forecasts are falling, and they are falling rather universally for FY23. UBS suspects this process might accelerate throughout the final week.

The sector with most positive surprises, on UBS's observation, is thus far the insurance sector with forward-looking estimates carried higher on projected benefits from higher interest rates. Maybe it should then not come as a surprise that victims of higher interest rates, the local REITs, have thus far been most underwhelming.

The culprit for that sector is debt. With higher interest rates, the heavier burden to service debt is seriously eating into growth prospects for many a local REIT.

But, as UBS points out, resources companies are receiving most of the downgrades for earnings estimates in the year ahead as analysts' focus remains firmly on the tougher economic outlook ahead.

In general terms, UBS is not too unhappy with the local share market set-up, noting the forward-oriented price earnings (PE) ratio for the ASX200 was below 14x pre-August. This is below the long-term average of 14.5x and certainly a lot lower than the 17x-20x multiples seen prior to preceding reporting seasons in recent years.

Equally important: the ongoing cuts to forecasts have not stopped share prices from putting in a strong performance since mid-June. UBS observes the ASX200 has gained some 8% over the last month, with the index rallying 10% since bottoming in June.

With history showing Australian equities tend to hold on to their gains during the after-season, UBS is hopeful 2022 will finish on a positive note:

"The markets rally since mid June has provided equities with more positive momentum than has been the case leading into recent reporting season.

"The continuation of this rally over the last fortnight, has matched the favourable reaction which we have become familiar with over recent years.

"Furthermore, with the exception of the COVID shocks of March 2020, Australian equities have tended to hold onto these gains over subsequent months."

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As reported in earlier editions, Macquarie strategists are a lot less optimistic than is UBS. They highlight the fact that, so far, dividends tend to "miss" expectations, while the average guidance communicated looks rather "soft".

Up until Friday, notes Macquarie, analysts are issuing twice as many downgrades to FY23 forecasts than upgrades. Among the positives is that free cash flows tend to surprise positively, especially from resources companies. (This contrasts with the dividend disappointments, suggesting boards are cautious).

Macquarie also notes there are fewer share buybacks being announced, which is yet another disappointment.

There haven't been too many examples of companies issuing guidance that well-exceeds market expectations, but Macquarie mentions Brambles and ReadyTech Holdings ((RDY)) as two examples.

Most companies, a la Credit Corp ((CCP)), CSL ((CSL)), Downer EDI ((DOW)) and Transurban ((TCL)), feel the need to reduce market expectations for the year ahead.

Macquarie counted only three companies that beat with their FY22 performance and experienced upgrades to FY23 forecasts last week: Medibank Private ((MPL)), Temple & Webster ((TPW)), and Qualitas ((QAL)).

This broker's overall market assessment reads a lot different from UBS's:

"We still think it is hard to make a bull case for stocks when valuations are already high, we are early in an earnings downgrade cycle and the Fed/RBA are likely to tighten further to slow inflation."

Macquarie's forecasts are positioned below consensus for Woolworths ((WOW)), Reece ((REH)), Nine Entertainment ((NEC)) and Fortescue Metals ((FMG)) suggesting, if Macquarie is correct, heightened risk for result disappointment.

The opposite might be true for Qantas Airways ((QAN)), Iluka Resources ((ILU)), South32 ((S32)), and Lynas Rare Earths ((LYC)) where Macquarie's forecasts are above consensus.

Macquarie is also keeping a close watch on inventories with most companies having reported to date showing higher-than-expected inventories. While the official explanation is usually in reference to preparation for supply chain bottlenecks, Macquarie nevertheless points out this can be an earnings risk as the cycle slows.

Macquarie's aggregate FY23 EPS forecast for the ASX200 is falling, but at 11.8% the strategists believe it remains too high for a US recession scenario next year. The FY23 EPS growth forecast for Small Industrials is now slightly negative.

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Equity strategists at JP Morgan, Jason Steed and Emily Macpherson, summarise the running August season as: Cost, Capex and Conjecture. The latter refers to companies issuing guidance (or not).

Rising costs and the ability to keep a lid on input inflation is dividing corporate Australia in August, suggests JP Morgan, with the likes of ASX, Domain Holdings Australia ((DGH)) and Transurban in the not-coping-well basket and the likes of BHP, Brambles, REA Group ((REA)) and Treasury Wine Estates proving they are better suited in the present environment.

Equally notable is that several companies are ramping up capital expenditure (capex), but it's not always well-received.

JP Morgan points out higher capex guidance by BHP, Brambles and Sims ((SGM)) was well-received by investors. More importantly: JP Morgan finds there has been a trend of rising capex in recent years, and while moderating, this trend is expected to remain at elevated level in Australia.

Steed and Macpherson don't blame most companies for not providing a quantified outlook. They note Blackmores ((BKL)), Domain Holdings and Seek ((SEK)) gave it a shot, and it was not well-received.

Underlying, both strategists acknowledge, it's not shaping up as an exceptionally great season, but trends might simply be reverting back to pre-covid averages.

Irrespective, only 17% of reporters by the end of last week had enjoyed upgrades to forecasts by JP Morgan analysts, and this is well-below historical trends, as well as well-below the 43% that is seeing downgrades.

Some of the notable "beats" to forecasts have been, on JP Morgan's assessment, Brambles, Domain Holdings, Insurance Australia Group ((IAG)), Medibank Private, REA Group, Suncorp Group ((SUN)) and Telstra.

Key "misses" have been delivered by Aurizon Holdings ((AZJ)), Bendigo and Adelaide Bank ((BEN)), Computershare ((CPU)), James Hardie, and Magellan Financial ((MFG)).

At face value, analysts at JP Morgan seem a lot less active than their peers at, say, Macquarie with aggregate bottom-up EPS forecast for FY23 currently sitting at 3.9%, down from 4.1% pre-season.

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One additional observation to highlight is that companies that should benefit from improving market dynamics post-covid continue to enjoy market support, even as those companies are tempering analysts' expectations. Witness, for example, the CSL share price, or Cochlear's ((COH)) in recent days.

In terms of absolute stand-outs, the picking thus far has been extremely slim. Audinate Group ((AD8)) would be one logical nomination on the positive side with just about everyone in awe of how well management at this little technology gem has managed the operational headwinds.

Another logical nomination is Pro Medicus ((PME)), though its existence alone triggers heavy-handed debates on social media about "valuation" and what might already be priced-in.

Among the large caps, both BHP and Telstra rank highly on analysts' nominations, with both surprising positively with dividends.

Brambles and Carsales ((CAR)) are worth mentioning too, but macro-considerations are ever-present, which means positive performances from companies including Corporate Travel Management ((CTD)), Super Retail and Seek are not receiving the rewards they would otherwise enjoy under different circumstances.

This year's tougher environment is preventing many of your typical strugglers to put in a come-back performance, with the likes of AGL Energy ((AGL)), Appen, Aurizon Holdings, Inghams Group, GWA Group ((GWA)), Magellan Financial, and Pact Group once again proving successfully turning around under difficult conditions is mostly wishful thinking.

What Happened To That Recession?

And in the end… corporate results season throughout August was not as bad as many had feared.

The obvious observation to add is that while most companies managed to cope with rising input costs, supply chain bottlenecks and staff absenteeism (if not shortages), the truth of the matter is most sectors in Australia have been enjoying ongoing strong demand for their products and services – and that might just be the one key factor that is about to change.

That prospect, and the persistent message from central bankers that tightening policies are continuing for longer since inflation remains too elevated for comfort, meant the August price action and share price responses always had a macro factor attached.

To achieve a positive share price follow-through that lasted longer than one day, companies needed more than a forecast-beating result. They also needed a strong, confident and believable guidance for the year ahead, without the prospect of having to face macro-headwinds from rising interest rates, and without macro-inspired selling to interfere.

For many a share price, those were simply too many conditions that needed to be fulfilled. The Australian share market is likely to conclude August with a small gain, helped by last-day-of-the-month support from institutional investors, which might as well serve as the perfect summary for the season: it wasn't too bad, but the prospect remains of recession ahead for the world's largest economies.

In particular following Jay Powell's speech at Jackson Hole, this prospect is poised to remain longer on investors' mind post-corporate results.

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The final stats have not yet been established, but there are sufficient indications corporate Australia performed reasonably 'ok' during the first six to eight months of calendar 2022. Investors need not look any further than market updates on the final day from the likes of Harvey Norman ((HVN)) and Webjet ((WEB)) – both beat forecasts but with different share price responses.

With 318 results included, the FNArena Corporate Results Monitor has registered 96 (30%) companies beating market expectations against 85 (26.7%) "misses" and 137 (43%) reporting in line with forecasts. In response, analysts have issued 76 rating downgrades versus only 27 upgrades, while the average individual price target was cut by -2.25%.

These numbers are not the kind of numbers that describe a positively inspiring results season, but it equally has not been the worst outcome post-GFC – far from.

The August season of 2019, for example, was a decisively worse experience with FNArena only registering 24% "beats", outnumbered by 25% "misses", and soon after banks and cyclicals started announcing dividend cuts, even before covid presented itself months later.

This time around dividends, on balance, still managed to surprise on the upside even though many are expecting leaner payout times are forthcoming.

Many of the surprises this season stemmed from cyclical companies, coal, iron ore and energy producers included, but virtually no one thinks this year's cash abundance for the likes of Whitehaven Coal ((WHC)), Woodside Energy ((WDS)) and Fortescue Metals ((FMG)) will prove sustainable, though it also doesn't by default mean the end of extra benefits for shareholders in these companies either.

On calculations by Wilsons, Australia's Top10 companies in market cap paid their shareholders circa $50bn in dividends, including Woodside's largest interim-payout in eight years and the first dividend increase from Telstra ((TLS)) in seven years.

There was equally excitement in the smaller cap space with Cronos Australia ((CAU)) achieving profitability and declaring a 1c dividend for shareholders; the first ever by an ASX-listed medicinal cannabis company.

Plenty of signals around suggesting payout ratios have peaked, also because boards including Rio Tinto's ((RIO)) are preparing to invest more to secure growth at the other end of the cycle. Also, plenty of dividend payouts were supported by asset sales or merger-benefits.

In addition to dividends, companies are equally still keen to buy in their own shares, with a2 Milk ((A2M)), Nine Entertainment ((NEC)), Northern Star ((NST)), Qantas Airways ((QAN)), Santos ((STO)), and Whitehaven Coal all announcing fresh buybacks.

In the end, a majority of companies (circa 60%) managed to outperform estimates, but about two-thirds saw analysts subsequently cutting forecasts for the year ahead. As a result, the strong 20% growth in aggregate EPS achieved in FY22 is now forecast to be followed up by circa 6% only in FY23. And market strategists are still of the view that further downgrades will be forthcoming.

Wilsons, for example, has now joined UBS's prediction EPS forecasts in Australia might remain under pressure for another six months. Economists at Jarden predict the relative resilience of consumer spending in Australia will start weakening by year-end because of the lagging impact from RBA rate hikes.

The RBA, similar to other central banks, is expected to continue hiking rates at upcoming board meetings.

Jarden: "reduction in spending is what central banks need to achieve in order to bring inflation back into line with targets".

The team of retail analysts at the firm believes covid-beneficiaries, such as household goods, are most at risk in the period ahead, hence Jarden is less keen on JB Hi-Fi ((JBH)), Harvey Norman, Nick Scali ((NCK)) and Kogan ((KGN)). Instead, consumer staples should prove safer, along with typical value-plays and companies servicing youth or higher-income consumers, or those still enjoying the spoils from society re-opening.

Jarden's preference thus lays with the likes of Treasury Wine Estates ((TWE)), Universal Store Holdings ((UNI)), Flight Centre ((FLT)), Domino's Pizza ((DMP)) and Metcash ((MTS)).

Having said this, every season generates its number of disappointments and this time these did not include Telstra, AMP ((AMP)) or QBE Insurance ((QBE)) but your typical defensives: supermarkets, REITs and utilities. Higher costs and rising rates in many cases proved too much to absorb.

The same observation can be made for producers of commodities, especially among smaller cap companies, and in particular the producers of gold. This may yet prove a harbinger of what lays ahead, with Wilsons commenting:

"We believe the current dynamic of passing costs onto consumers cannot last forever, and companies (unless they have a significant competitive advantage) may have to change tact before the end of this calendar year.

"This could lead to margin pressure for many sectors in the ASX 200."

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Among mining companies that disappointed were Aeris Resources ((AIS)), Champion Iron ((CIA)), Sandfire Resources ((SFR)), OZ Minerals ((OZL)), Panoramic Resources ((PAN)), Pilbara Minerals ((PLS)), Resolute Mining ((RSG)), West African Resources ((WAF)), and Westgold Resources ((WGX)).

On UBS's assessment, the Materials sector suffered most from analysts cutting forecasts this month with both miners and building materials companies struggling to cope with input cost pressures. Financials, on the other hand, held up well as banks proved solid and insurers triggered upgrades.

Energy stocks were the stand-out performer thus far in 2022, which equally matches the sector's outperformance overseas.

One conclusion that gained traction throughout the month is that many shares had been sold down too far and those companies sit high on the list of outperformers this month. Consider, for example, the most successful sector in August was Information Technology where, according to Wilsons, 80% of companies beat analysts' estimates, followed by Real Estate (72%) and Financials (65%).

Technology stalwarts that surprised positively this month include Altium ((ALU)), Hub24 ((HUB)), IPH ((IPH)), and Megaport ((MP1)).

Equally important, some of the most highly valued companies on the market continued to add to their success story, including Audinate Group ((AD8)), IDP Education ((IEL)), Lovisa Holdings ((LOV)), Pro Medicus ((PME)) and WiseTech Global ((WTC)). Plenty of others provided lots of evidence it's too big of an ask to achieve a successful turnaround when overall conditions are this challenging, and likely to worsen.

Examples: Appen ((APX)), Aurizon Holdings ((AZJ)), Estia Health ((EHE)), GWA Holdings ((GWA)), Inghams Group ((ING)), Magellan Financial ((MFG)), Mayne Pharma ((MYX)), Nuix ((NXL)), Ramsay Health Care ((RHC)), Wagners Holding Co ((WGN)), and Zip Co ((ZIP)).

Macquarie points out the Australian market (ASX200) is trading on a Price Earnings (PE) ratio of 14.5x on December forecasts and 14.4x on forecasts to June 2023. Macquarie analysts have only 2.6% EPS growth in aggregate left for FY23, followed by 1.2% for FY24. The aggregate forecast for both years is negative for Resources. Macquarie has adopted the view there will be a (global) recession next year.

In small contrast, analysts at Citi remain convinced the Australian economy is likely to remain relatively resilient for longer. Thus their EPS forecast is for 7.7% growth in FY23, followed by a negative -6% in FY24. The Resources sector on Citi's forecasts will still enjoy a year of positive EPS growth ahead (just!), but then fall off the proverbial cliff by FY24 (-23%).

The key difference in these forecasts hides in the timing of when exactly economies will feel the impact from central bank tightening, as well as to the severity of it all.

Adds UBS: "We note that over the past 20 years, the average annual earnings growth delivered by Australian companies has been 5.5%.

"Given input cost pressures are not going away, labour supply issues will remain, and interest rates still have further to rise, we would be impressed if 2023 earnings growth is able to meet this historical mark."

One positive is the Australian share market is again offering a prospective yield in excess of 4%, ex-franking.

Concludes Wilsons:

"We currently believe quality is the best place for equity portfolios, within a backdrop of a slowing growth, margin compression and heightened uncertainty.

"Quality companies that have the ability to pass on costs should be well placed as broader margin compression plays out.

"Over the next year, we expect global economic growth and earnings growth to slow significantly. As a result, companies with high quality, resilient earnings streams should be increasingly sought-after by the market and this should lead to outperformance."

Within this framework, Wilsons points at Cleanaway Waste Management ((CWY)), CSL ((CSL)), James Hardie ((JHX)), Lotteries Corp ((TLC)), Telstra, and ResMed ((RMD)).

August Reports: Closing Remarks

The key attraction for investing in small and micro cap companies is the ability to generate oversized gains when things fall into place at the right time.

But just about every reporting season shows the opposite holds equally true and this time around the true stinkers from the August reporting season are called PPK Group ((PPK)), Redbubble ((RBL)) and Appen ((APX)).

In particular the erosion in the share price of "innovative technology investor" PPK Group looks genuinely gut-wrenching since the share price peaked above $21 in July last year. In August, the stock lost an additional -40%, pulling it closer to $1.52.

The thesis that when market dynamics toughen up, smaller cap stocks become relatively more vulnerable doesn't need such extreme examples to prove its validity. One look into the finer details of the FNArena Corporate Results Monitor can be just as revealing, and affirmative.

At face value, the inclusion of 344 corporate results released in August has generated 30.8% better-than-forecast results while 26.7% disappointed and 42.4% simply fell in line with guidance and/or expectations. The numbers look decisively better when we zoom in on respectively the ASX50 and ASX200.

Of the 44 companies of the ASX50 that reported in August only 20% (9 companies) were marked down as a "miss" with 29.5% (13 companies) surprising to the upside. For the 161 companies of the ASX200 the numbers don't look fundamentally different: 23.6% disappointed (38 companies) against 32.5% (52 companies) that delivered a better-than-expected performance without also issuing negative guidance for the year ahead.

These statistics reveal that when it comes to "disappointments", the percentage of negative market updates is noticeably higher for small cap companies that are outside of the ASX200. Apart from PPK Group, the list of small caps delivering big disappointments in August includes the likes of Kina Securities ((KSL)), Polynovo ((PNV)), Service Stream ((SSM)), SiteMinder ((SDR)), Southern Cross Media ((SXL)), and Veem ((VEE)).

Admittedly, the outsized punishments have been matched by significant gains for the likes of Nearmap ((NEA)), Tyro Payments ((TYR)) and Lovisa Holdings ((LOV)).

One of the key reasons as to why smaller companies are more vulnerable is the lack of a genuine moat or pricing power, while a relatively minor headwind can cause major problems when the company is only small-sized.

But one of the key observations from the August results is equally deserving to be highlighted: as a population, we had been all too eager to return back to old habits from the moment covid-restrictions and lockdowns became a thing of the past.

The demise in 2022 of former high flyers such as Booktopia Group ((BKG)) and Redbubble is equally evidence that, as a community of analysts, investors and speculators, we had been too eager to accept that covid had pulled some of the megatrends into irreversible acceleration.

As it turned out, those megatrends including working from home and spending online simply went through an artificial growth-spurt; one that was quick to deflate from the moment the valve was released.

There is no stopping these trends, of course, and they will most likely continue for many years yet to come. But many of the companies that were previously riding on the coat tails of megatrend market enthusiasm might now be facing a tough twelve months ahead.

And that's on top of this year's new market-led requirement that companies not profitable or cash flow positive establish and communicate a plausible pathway to break-even.

Given the many question marks and uncertainties ahead, it should be no surprise investors are, on average, not in a mindset of giving such small cap companies the benefit of the doubt before anything concrete shows up in financial numbers.

While cheap-looking share prices can always attract the interest from a corporate suitor, as has happened for Nearmap, Nitro Software and Link Administration ((LNK)), in the absence of a take-over, investors might have to be patient for longer before share prices in companies such as Aussie Broadband ((ABB)), Fineos Corp ((FCL)), Life360 ((360)) and Megaport will see sustainable momentum return.

And given so many worries about how ongoing tightening by the US Federal Reserve, and the RBA here in Australia, will deflate the housing market, and how that will impact on household spending, and exactly when, it seems very likely the same patience might have to be tapped into for ASX-listed consumer and housing-related companies.

Comparing the August stats with prior years, the final balance is far from fantastic, in particular the relatively high percentage of "misses", but also the -2.95% adjustment in average individual target price.

With two-thirds of companies seeing forecasts reduced post results release, one of the key questions for the six months ahead remains whether those reductions are now appropriate, or still too high.

I don't like to see the world through the prism of bears versus bulls, but in trying to ascertain the most plausible answer to that question, it quickly becomes apparent there's a big divide between the optimists and everybody else.

For Macquarie, where preparations are being made for a global recession in 2023, the August season looked pretty disappointing with the broker's aggregate EPS forecast literally melting away throughout the month, starting from a positive 15% in growth to ultimately end up with a negative -0.4% forecast.

As the analysts highlight, many of such downgrades to growth forecasts have been driven by company guidance of which about 50% came out below consensus. In line with my earlier observations, the rate of downgrades was higher for smaller cap companies. Macquarie equally adopted a more cautious view towards commodities, including iron ore and copper.

Macquarie is understandably rather cautious about the near-term trajectory for equities, now also explicitly referencing the step up in quantitative tightening by the Federal Reserve, starting this month (September).

But then one reads JP Morgan and it's almost as if we need to check the date on the report. Is this really about the same Australian companies in the same month of August this year?

Consider that, contrary to general practice elsewhere, JP Morgan analysts ended up with higher EPS forecasts following the onslaught of August corporate results. Pre-season the forecast was for 4.2% EPS growth in FY23. That number has now grown to 4.6%.

Six sectors are responsible for the increase: Communication Services, Energy, REITs, Industrials, Materials and Discretionary retailers with truly stand-out positive surprises delivered by companies in Technology, Communication Services and Industrials.

The biggest disappointments, as far as JP Morgan's forecast adjustments are concerned, came from utilities, consumer staples and healthcare companies.

The obvious observation to make is the sharply different starting point for both teams of analysts, but this still leaves the question open: is the -0.4% forecast from Macquarie now too low or is the 4.6% from JP Morgan too high?

The answer for individual investment portfolios will be found in specific individual companies. Whenever someone predicts it's becoming a stock pickers' market now, I tend to agree. Wide divergences are likely to characterise share markets and sectors internally.

On JP Morgan's assessment, the difference between its own projections and those of other forecasters can be explained through the Energy sector. JP Morgan has higher forecasts for Woodside Energy ((WDS)), Santos ((STO)) & Co, which also implies its forward projections are not that different from Macquarie for other sectors, such as the miners.

Conclusion: the outlook is for subdued growth ahead. With the local share market trading in line with its long-term PE average of circa 14.5x, does this then seem appropriate?

I have real doubt. Also because it seems but a valid thesis that the full impact from central bank tightening has yet to be felt across economies. I think it's best to adopt a more cautious stance, not in the least because mid-September/mid-October traditionally can be a very tricky period.

With Jay Powell's Jackson Hole speech continuing to reverberate, and quantitative tightening drawing more liquidity out of markets this month, I think the weeks ahead can become very tricky to navigate indeed.

Conviction Calls

Technology sector analysts at Goldman Sachs have been, overall, pleased with corporate results released in August.

Among the positives cited is the fact most non-profitable businesses have changed strategy towards an accelerated pathway to becoming break-even.

The team at Goldman Sachs has grabbed the opportunity to reiterate their Buy calls for REA Group ((REA)), Xero ((XRO)), Domain Holdings Australia ((DHG)), Megaport ((MP1)), Nitro Software ((NTO)), ReadyTech Holdings ((RDY)), and Objective Corp ((OCL)).

REA Group is on the broker's Conviction List.

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Three to four years of limited growth. Such is the prediction of REIT-sector analysts at Jarden regarding the impact from higher bond yields and interest rates.

The underlying suggestion: time to be more selective!

Jarden: "Our analysis shows that the rising cost of debt will hold back earnings growth for at least 3-4 years, as cheap hedges roll off. This is particularly evident in passive and externally managed REITs. We prefer REITs that have been able to reset interest expense early and those with stronger top-line momentum."

The broker has seven REITs on a Buy rating: Scentre Group ((SCG)), Charter Hall ((CHC)), Lifestyle Communities ((LIC)), Centuria Capital Group ((CNI)), Ingenia Communities Group ((INA)), Shopping Centes Australasia Property Group ((SCP)), and Abacus Property Group ((ABP)).

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Healthcare analysts at Macquarie have nominated CSL ((CSL)) and Healius ((HLS)) as their two top picks, with both ResMed ((RMD)) and Ansell ((ANN)) equally carrying the broker's Outperform rating.

Two companies are currently Sell-rated: Cochlear ((COH)) -downgraded in August- and Sonic Healthcare ((SHL)).

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Macquarie has also communicated its preferences among A-REITs, with the broker still not keen on office, discretionary malls or residential properties.

The greater defensive qualities are to be found in the small to mid-cap space, argues the broker, where exposure to convenience retail through HomeCo Daily Needs REIT ((HDN)) or Charter Hall Retail REIT ((CQR)) has its preference, as does HealthCo Healthcare & Wellness REIT ((HCW)).

Active fund managers remain on the broker's wishlist though Outperform-rated Goodman Group ((GMG)), Charter Hall and Qualitas ((QAL)), supplemented for this time with Lendlease ((LLC)); the latter on confidence in a FY24-recovery.

The greatest level of caution is reserved for Stockland ((SGP)), Scentre Group, Vicinity Centres ((VCX)) and National Storage ((NSR)).

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Goldman Sachs' advice for investors looking to increase exposure to A-REITs is to focus on cash flow and dividend sustainability, with REITs that have a lower payout currently considered best-placed to increase dividends in the years ahead.

Goldman Sachs likes the fund managers Goodman Group and Home Consortium ((HMC)), as well as Stockland for residential exposure, and GPT ((GPT)) as a 'value' play.

For retail exposure, Goldman Sachs points at Scentre Group and HomeCo Daily Needs REIT, while this broker also likes HealthCo Healthcare & Wellness REIT, Charter Hall Social Infrastructure REIT ((CQE)), as well as Waypoint REIT ((WPR)).

Charter Hall Social Infrastructure REIT is included in the broker's Conviction List.

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Morgan Stanley's Australia Macro+ Focus List contains the following ten stocks:

Amcor ((AMC)), Computershare ((CPU)), CSL, Goodman Group, Macquarie Group ((MQG)), Orica ((ORI)), Qantas Airways ((QAN)), QBE Insurance ((QBE)), Woodside Energy ((WDS)), and Telstra ((TLS)).

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Insurance sector analysts at Credit Suisse have nominated QBE Insurance as their top pick, followed by (in order of preference) Suncorp Group ((SUN)), Insurance Australia Group ((IAG)), AUB Group ((AUB)), Steadfast Group ((SDF)), Medibank Private ((MPL)) and nib Holdings ((NHF)).

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Small cap specialists at JP Morgan have GUD Holdings ((GUD)) as their Top Pick and Appen ((APX)) as their Bottom Pick (least preferred).

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Macquarie's team of technology analysts has nominated Megaport as the sector's Top Pick while Appen is least-preferred.

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Stockbroker Morgans believes health insurers Medibank Private and nib Holdings delivered some of the strongest performances among insurance and diversified financials companies, alongside equally strong performers QBE Insurance, Tyro Payments ((TYR)) and Generation Development Group ((GDG)).

Two of the weakest performances, in the broker's view, were delivered by Suncorp Group ((SUN)) and Challenger ((CGF)).

Morgans' order of preference is currently QBE Insurance on top, followed by Computershare, Suncorp, Generation Development Group, Tyro Payments, Challenger, with Kina Securities ((KSL)) last in line.

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A cautious Macquarie, still focused on the global recession that is anticipated for 2023, keeps singing the praise of defensive sectors such as paper & packaging.

In Australia, the broker's sector favourite is Orora ((ORA)) with Pact Group ((PGL)) least preferred and Amcor in the middle.

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Dave Rosenberg: "It is suggested investors brace themselves — book profits, reduce worrisome positions, tighten stops, and/or apply option strategies — the next few weeks could prove treacherous."

Conviction Calls

This week's line-up of Conviction Calls is possibly the largest ever. Feel free to save, print, compare, analyse, or use in any way that suits best.

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"We are passionate about software" repeat Jules Cooper and Josh Goodwill with every sector update for stockbroker Shaw and Partners.

The duo has recently become enthusiastic about Playside Studios ((PLY)), Australia's largest independent game developer. This sounds like a big medal to carry, until one realises total market cap is still less than $300m. It's a minnow, and we don't use the term as a form of insult.

Playside Studios might be en route to breaking even in 2024, and that would be a positive milestone. Shaw lauds the company's "record game launch pipeline" in the short term.

Shaw's initiation of coverage occurred last week, with a maiden Buy rating (of course) and 90c price target.

So enthusiastic are the two software aficionados, the stock has been added to Shaw's Top Picks for the ASX-listed sector, joining Gentrack Group ((GTK)), Elmo Software ((ELO)), ReadyTech Holdings ((RDY)) and Mach7 Technologies ((M7T)).

Equally noteworthy: Shaw's Top Three of August reporting season highlights (as far as software companies are concerned) refers to ReadyTech, Elmo Software, and Mach7 Technologies. Pretty much a confirmation of the team's favouritism.

The only three software companies covered and not rated Buy are Nitro Software ((NTO)) and PushPay Holdings ((PPH)) -both under take-over interest- rated Hold, and Iress ((IRE)) on Sell. Shaw doesn't like Iress, and hasn't for a long while.

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Stockbroker Morgans has used the August market updates to remove each of Reliance Worldwide ((RWC)), Eagers Automotive ((APE)) and Challenger ((CGF)) from its extensive list of Best Ideas among ASX-listed companies.

Only one sole addition was made: Domino's Pizza ((DMP)).

Morgans' full list now consists of 31 stocks, in alphabetical order:

-Acrow Formwork and Construction Service  ((ACF))
-AGL Energy ((AGL))
-Aristocrat Leisure ((ALL))
-BHP Group ((BHP))
-Corporate Travel Management ((CTD))
-Dalrymple Bay Infrastructure ((DBI))
-Dexus Industria REIT ((DXI))
-Domino's Pizza
-GQG Partners ((GQG))
-Healius ((HLS))
-HomeCo Daily Needs REIT ((HDN))
-IDP Education ((IEL))
-Incitec Pivot ((IPL))
-Jumbo Interactive ((JIN))
-Karoon Energy ((KAR))
-Lovisa Holdings ((LOV))
-Mach7 Technologies
-Macquarie Group ((MQG))
-NextDC ((NXT))
-Nufarm ((NUF))
-Pro Medicus ((PME))
-QBE Insurance Group ((QBE))
-ResMed ((RMD))
-Santos ((STO))
-Seek ((SEK))
-South32 ((S32))
-Technology One ((TNE))
-Transurban Group ((TCL))
-Treasury Wine Estates ((TWE))
-Webjet ((WEB))
-Wesfarmers ((WES))

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The local Conviction List at Goldman Sachs is equally as diverse, but with only 11 stocks:

-Charter Hall Social Infrastructure REIT ((CQE))
-Elders ((ELD))
-HealthCo Healthcare & Wellness REIT ((HCW))
-Iluka Resources ((ILU))
-Lifestyle Communities ((LIC))
-NextDC
-Omni Bridgeway ((OBL))
-Qantas Airways ((QAN))
-REA Group ((REA))
-Westpac Banking ((WBC))
-Woolworths Group ((WOW))

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The list of Best Stock Ideas at UBS has been extended with Aristocrat Leisure ((ALL)), Telstra ((TLS)) and Worley ((WOR)), and reduced by removing James Hardie ((JHX)) and Stockland ((SGP)) as the in-house stockpickers fear both are set to remain hostage to a tough-looking macro-environment.

TPG Telecom ((TPG)) was equally removed as the telco's financial report in August was deemed "poor".

UBS runs a parallel list of Least Preferred stocks and here Adbri ((ABC)), Charter Hall Long WALE ((CLW)) and Insurance Australia Group ((IAG)) are no longer included.

With exception of Adbri, these share prices have not performed as maybe had been feared, but clearly, UBS's conviction in further downside has reduced for all three.

Retain their inclusion on the Least Preferred list are:

-Bega Cheese ((BGA))
-Endeavour Group ((EDV))
-Harvey Norman ((HVN))
-InvoCare ((IVC))
-Lifestyle Communities
-Magellan Financial Group ((MFG))
-Macquarie Group

Bega Cheese, Endeavour Group and Lifestyle Communities are fresh additions.

Post the aforementioned changes, UBS's Best Stock Ideas now comprises of the following ideas:

-Amcor ((AMC))
-ANZ Bank ((ANZ))
-Aristocrat Leisure
-BHP Group
-Computershare ((CPU))
-IDP Education ((IEL))
-IGO ((IGO))
-Metcash ((MTS))
-NextDC
-Origin Energy ((ORG))
-Qantas Airways
-QBE Insurance ((QBE))
-Santos ((STO))
-Seven Group Holdings ((SVW))
-Steadfast Group ((SDF))
-Telstra
-Transurban ((TCL))
-Treasury Wine Estates ((TWE))
-Wesfarmers
-Worley

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Referring back to the August results, stockbroker Morgans strong message to investors is that rewards shall be yours if you decide to invest in "quality", which in the broker's view includes mid-to-small cap stocks caught up in macro volatility.

Morgans best ideas from the recent reporting season include BHP Group, Santos, Domino's Pizza, Wesfarmers, Treasury Wine Estates, ResMed, Seek, Corporate Travel Management, NextDC, Home Consortium ((HMC)), IDP Education, and Lovisa Holdings.

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August reports have equally shaken up sector rankings at Credit Suisse where diversified financials in particular have been in focus.

Despite a downgrade to Neutral, Computershare remains most favourite among the diversifieds, beating all of Challenger, Link Administration ((LNK)) and the ASX ((ASX)).

Hub24 ((HUB)) is the most preferred local platform operator and when it comes to asset managers, Perpetual ((PPT)) sits on top.

All platform operators are Overweight-rated, so investors owning Netwealth Group ((NWL)) or Insignia Financial ((IFL)) don't have to feel bad about their choice.

While asset managers on average are trading at a sizable discount of circa -30% relative to the ASX200, Credit Suisse views this as "fair", also given outflows are expected to persist into 2023.

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More highlights from the August results season, according to Goldman Sachs (with the broker's forecasts more positive than market consensus, suggesting the rest of the market has yet to catch-up):

-Cochlear ((COH))
-Genworth Mortgage Insurance Australia ((GMA))
-Johns Lyng Group ((JLG))
-REA Group
-Reliance Worldwide
-ReadyTech Holdings

But there are equally stocks where the broker believes market expectations are currently too high (suggesting a negative catch-up is due):

-Bega Cheese
-CommBank ((CBA))
-Sonic Healthcare ((SHL))

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Citi's preferred exposures among A-REITs are Goodman Group ((GMG)) and Shopping Centres Australasia Property Group ((SCP)) -for their exposure to underlying income growth- and Mirvac Group.

The latter is considered owner of a quality portfolio that is currently not properly valued by the market.

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Technology sector analysts at JP Morgan are no different from their peers elsewhere; the August season has simply steeled their conviction even more there are multiple opportunities waiting to be scooped up by investors who are able to look through shorter-term volatility and general sector disliking.

Are currently carrying the highest rating of Overweight at JP Morgan:

-Altium ((ALU))
-Bravura Solutions ((BVS))
-Dicker Data ((DDR))
-Iress
-NextDC
-Superloop ((SLC))
-Tyro Payments ((TYR))
-WiseTech Global ((WTC))
-Xero ((XRO))

Extending the focus on gaming and media/internet operations, JP Morgan also carries Overweight ratings for:

-Aristocrat Leisure
-IDP Education
-News Corp ((NWS))
-Nine Entertainment ((NEC))
-Playside Studios
-REA Group
-Seek
-Star Entertainment Group ((SGR))
-The Lottery Corp ((TLC))

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From Wilsons' latest Focus List update:

"The risk still looks to the downside for earnings over the next 6 months as demand gets weaker, margins come under pressure as costs remain elevated, and the global economy starts to slow at a faster rate.

"As earnings become the focus of the second half of this year, we continue to shift our orientation towards quality earnings."

Wilsons added NextDC for this specific reason, while also removing Judo Bank ((JDO)) and trimming its holding in BHP Group. Exposure to ResMed has been increased.

And thus the Focus List is carrying the following stocks:

-Allkem ((AKE))
-ANZ Bank
-Aristocrat Leisure
-BHP Group
-Cleanaway Waste Management ((CWY))
-CSL ((CSL))
-Goodman Group
-HealthCo Healthcare & Wellness REIT
-Insurance Australia Group
-James Hardie
-Macquarie Group
-National Australia Bank ((NAB))
-NextDC
-News Corp
-Northern Star ((NST))
-OZ Minerals ((OZL))
-Pinnacle Investment Management ((PNI))
-Qantas Airways
-ResMed
-Seek
-Santos
-Tabcorp Holdings ((TAH))
-Telix Pharmaceuticals ((TLX))
-Telstra
-The Lottery Corp
-Westpac
-Woodside Energy ((WDS))
-Xero

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Technology analysts at Macquarie stand out as they foresee downward pressure on advertising, which defines their preferences inside the local TMT sector, which combines telcos, media and technology in the broadest interpretation.

Hence, Macquarie's sector pick is Carsales ((CAR)), alongside IDP Education and oOh!media ((OML)). Not keen is the broker on Seek and REA Group. Among telcos, Telstra is most preferred.

Macquarie's view is the ad cycle will turn in the first half of 2023, which is why the broker does not like any of the traditional media companies at this stage.

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Retail analysts at Jarden have created three buckets of companies to favour ahead of the predicted "spending cliff" in 2023:

-for exposure to consumers that can afford to keep spending; Universal Store Holdings ((UNI)), Accent Group ((AX1)) and Premier Investments ((PMV))

-for defensive business models with pricing power; Woolworths ((WOW)), Treasury Wine Estates, Costa Group ((CGC)) and Wesfarmers

-companies with a growing moat and return on invested capital ((ROIC)); Flight Centre ((FLT)), The Reject Shop ((TRS)), Wesfarmers, and Woolworths

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