- Earnings trends remain remarkably stable despite widespread expectations of an impending earnings slowdown. While the 9% rally in the ASX200 and subdued outlook statements might temper some good results, we still see potential upside surprises in February.
- Quantity and quality of earnings will come into focus as the macro takes a back seat to company fundamentals. Key themes to watch include: the risk of hiding in defensives, small-cap/cyclical rotation, focus on cashflow and operating leverage, short selling signals and revisiting REITs.
- Morgans analysts preview the results for 150 stocks under coverage that report in February and call out likely surprise and disappoint candidates from page 10.
- Key tactical trades (page 3) include CSL, ResMed, A2 Milk, Domino’s Pizza, Tyro and Megaport, among many others.
Watch
We reset our strategy following the 9% run since November
We update our strategy heading into February. First on the back of the late surge in 2023, we advocate being opportunistic on pullbacks.
Second, given the ongoing macro concern, we do not think the “focus on fundamental” regime is over - anything other than a path back to historically low rates and plentiful liquidity is likely to keep investors on the hunt for near-term cash and earnings generation. And last, cyclicals typically find valuation support as interest rates come down, providing an attractive alternative to growth and defensives.
Rising rates, recessionary fears and weak investor sentiment provided plenty of reasons for investors to hide in defensives in 2023. However, as conviction around a cyclical peak in interest rates firmed, a rotation to growth and cyclicals ensued late in the year with defensives all underperforming the ASX200.
We continue to favour a rotation away from defensives (telco, staples) as earnings growth broadens across the market.
Look below the surface – solid earnings growth on offer
We see the S&P/ASX 200 index rangebound in 2024. FY24 EPS is forecast to decline 5% before rebounding 5% in FY25, leaving the heavy lifting down to P/E multiple expansion, but at 16x vs the 14.5x 20-year historical average, there is limited scope for further expansion barring a sharp retreat in interest rates.
While we do not expect the index to do much at the headline level, high-level numbers conceal significant variation across sectors. Cyclicals including consumer and commercial services, media, retail and capital goods offer mid-to-high EPS growth into FY24 at lower relative valuations.
Cyclical stocks that look interesting include Acrow, GQG Partners, Alliance Aviation, Baby Bunting and Santos.
Small-caps continue to look constructive
Small-caps have historically bounced hardest upon confirmation of a flattening-out in the rates cycle. Several ingredients remain in place supporting a rebound in this space (rates, trading/fundamentals, sentiment/positioning).
We think the tide is turning for small-caps, and now is an opportune time to build exposure to forgotten small-caps including Helloworld, Credit Corp, IPH Limited, Clinuvel, Veem, Vulcan Steel and DGL Group.
Time to rethink REITs
REITs was the best performing sub-sector of the ASX200 in late 2023 on broadening views that the rates cycle in major economies has likely peaked and that material rate cuts are possible in 2024.
While we still see some earnings risk in Retail and Office that could weigh on the sector and valuations on the balance sheets that could fall in 2024, the downside looks more than priced in when we look at discounts to NTA of 20-40%.
We also expect strong balance sheets to help buffer any falls in book values. Our preferred A-REITs are Goodman Group, Qualitas, HomeCo Daily Needs REIT and Dexus Industria REIT.
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