Rudi’s View: In Corporate Earnings We Must Trust

Rudi's View | 10:00 AM

Is it possible general worries are simply too negative as equities continue their ascent?

By Rudi Filapek-Vandyck, Editor

This time last year the buzz around equity markets was all about expensive valuations, a narrow market breadth and concerns about AI momentum having rallied too quickly too far.

Sounds familiar?

There were a few stumbles here and there, including a weak start into the new calendar year, but equities kept on trending upwards until that shock announcement on tariffs from the new administration in the White House sent markets into a brief sell-off.

Would markets have sold off without the threat of unprecedented US import tariffs?

We don't know, of course, as we cannot simply run an alternative history from which we can judge, but if strong price action post that April sell-off is anything to go by, I think the answer is negative.

So here we are again, one year later and the ASX200 is more than 12% higher, including dividends, while US markets have performed even better.

The S&P500 has generated a total return of 15.50% since and for the Nasdaq100 the total gain amounts to a smidgen under 24%.

Twelve months on and the buzz around equity markets hasn't changed much. If anything, concerns about expensive valuations and hundreds of billions spent on AI infrastructure have only attracted more attention.

All of this raises the obvious question: are investors too worried about expensive looking valuations and therefore missing the reason(s) why shares continue to trend into higher highs?

Corporate Earnings Support

A lot has been written about US indices, carried by a limited selection of Champion stocks, setting fresh all-time record highs in the face of tariffs and other threats.

What is seldom highlighted is that US corporate earnings for the first two quarters have been better-than-expected with a similar outcome anticipated for the Q3 season that commenced last week.

In Australia, the underlying dynamic hasn't quite been as positive, but there should be little doubt investors here too are adopting an optimistic outlook on corporate earnings for the year(s) ahead.

This is why the focus has returned to miners and smaller cap companies. In many cases, the improvement in earnings hasn't shown up yet, which can make a stock look expensive in the here and now.

Whether 'expensive' leads to a higher or lower share price might well depend on what earnings growth looks like.

That investor dilemma was perfectly illustrated on Monday when fast-runner Zip Co ((ZIP)) released yet another better-than-forecast quarterly market update, after which its share price was rewarded with a further 4%-plus gain.

Zip Co shares had already rallied close to 50% year-to-date and more than 300% from the April low.

A much cheaper priced Bapcor ((BAP)), on the other hand, issued yet another profit warning and its shares are being punished in excess of -18% in the aftermath.

Those shares hardly budged back in April, believe it or not, but Monday's fall pulls this year's loss to more than -43%.

Loyal shareholders will not want to be reminded this share price once traded north of $8.

We can replace Zip Co with NRW Holdings ((NWH)) or Dyno Nobel ((DNL)) and Bapcor with Treasury Wine Estates ((TWE)), but the key principle remains the same.

Should equity markets sell-off when corporate earnings are poised for upside surprise?

The question applies as much to the US as it does to the local market.

Return Of Earnings Optimism

As can also be observed from FNArena's weekly updates (every Monday morning), general optimism regarding corporate earnings is unmistakenly in a renewed uptrend post the August results season.

While much of this stems from higher commodity prices, including rampant rallies for silver and gold, the likes of SRG Global ((SRG)), Telix Pharmaceuticals ((TLX)) and Regal Partners ((RPL)) are equally enjoying upgrades.

Thus far, corporate results in Australia post August are nothing to get excited about, but this can change dramatically in the weeks ahead when Newmont Corp ((NEM)), ResMed ((RMD)), Macquarie Group ((MQG)), Dyno Nobel, Orica ((ORI)) and three of the Big Four banks, among others, update on their financial performances.

But wait... there's also the local AGM season and Macquarie strategists have been predicting for weeks now the net outcome should be positive; i.e. we should see more of Zip Co-alike experiences and less disappointment a la Bapcor and Treasury Wine.

On Monday, those strategists updated their views for AGM outcomes, with positive updates expected from Codan ((CDA)) and Sigma Healthcare ((SIG)) this week.