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The battle to meet higher debt costs amid slowing economic growth will cause cracks to show in the finances of major listed companies abroad, prompting one of the worst profit decline cycles in recent history, according to local investment managers.
Milford Asset Management portfolio manager Will Curtayne warned a globalearnings recession was brewing, meaning profits would dive in the first half of 2023, before recovering in the latter half.
“We will see some pretty terrible company earnings at a global level.
“We think the United States [company] earnings will drop 20 to 25 per cent from their recent peaks. They’re maybe 5 per cent off the peak now. So that means there could be another 15 to 20 per cent fall to go.”
That profit pain would manifest from companies unable to hike prices to cover increased costs, including much higher debt interest repayments, as consumers cut back on spending.
Australian companies would suffer declines of up to 15 per cent, Curtayne said, but New Zealand’s sharemarket could be spared given its largest listed companies were power or telecommunication utilities less impacted by slowing economic growth.
Curtayne expected global equity markets to close the year with positive returns, but conceded there was a risk the downturn could last the whole year, resulting in a rare two-year streak of losses for investors.
“If that happens, you push out the equity market recovery until the next year, in 2024.”
Two consecutive years of losses had only occurred four times in the past century for the US benchmark S&P 500 index, including the tech bubble burst and Great Depression, he said.
All eyes on money supply
Harbour Asset Management portfolio manager Shane Solly said this earnings recession cycle came down to the supply of money for businesses, or lack thereof.
“With financial conditions tightening at their fastest pace since the 1970s to 1980s, earnings risk has increased.
“Equity markets may struggle to deliver consistent positive returns while money supply continues to be drained.”
Solly said the recession in earnings began rearing its head locally last year as companies’ debt costs increased from 4.5 per cent to 7.5 per cent per year, but this year companies could be forced to take action with cost-cutting measures.
“There is a risk for some companies that the earnings recession tests their financial strength.”
Solly said more investors had turned conservative, so could at least weather this storm better than last year.
Curtayne said Milford was holding more client funds in cash, and had reduced customer’s exposure to cyclical stocks in favour of defensive companies, like utilities. He was also optimistic on bonds.
Curtayne said Milford would sit on the share market sideline for some of this year, but was primed to pounce on stocks when profits fall by at least three quarters of his expectations. They had already fallen by about one quarter.
In other words; he wasn’t buying the dip, yet.
“We think it’s the time to hold in there. We don’t think it’s the time to sell either. If you’ve weathered equities thus far, you’re well into the second half of the sell-off.”
He expected markets to bottom out two months before profits find a floor, which could be in the second or third quarter of the year.
Other indicators to buy included seeing company valuations fall further and for central banks to halt interest rate hikes or reverse them.
Similarly, Solly wanted valuations to cheapen before buying back in.
“Overall, market valuation may not quite be compelling yet, given near-term earnings risk.”
Harbour Asset Management portfolio manager Shane Solly says investors are starting out this year more conservatively positioned with larger holdings of cash.
If investors were looking to buy, he advised them to go back to basics - checking a company’s cash flow, and considering if they had a durable competitive advantage.
He warned that some analyst estimates of company earnings were currently too optimistic, therefore the market was not fully accounting for the pain to come.
“The equity market isn’t always efficient in pricing major earnings downturns before they arrive.”
Curtayne saw the same market inefficiency as Solly, hence why he was waiting it out.
But, he was worried fed-up investors would abandon the share market, causing capitulation.
“Markets have largely gone sideways for six or nine months now. It wears investors down.”
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