Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 458

Confession season is upon us: What’s next for equity markets

The cash rate is on the path to normalisation following the Reserve Bank of Australia’s May rate rise. Governor Philip Lowe indicated that 2.5% was a more “normal level” but left scope to take a more nuanced path based on “evidence and data”. Key areas of interest are inflation – entrenched versus transitory – and whether high employment will result in wage increases.

Has this changed anything for equity investors? Not really

From a local perspective, our economy is strong with low unemployment and household spending power (including more than $250 billion of extra savings since the pandemic arose). This is a good environment for corporations and their profitability, driving future shareholder dividends.

What remains under pressure is equity pricing as higher interest rates impact the valuation of shares. Notwithstanding such headwinds, there are still some areas of the market which are expected to fare better than average, and these include:

  1. Commodities – continued high cash flow on elevated prices and continuing long-term demand trends.
  2. Financials - improvement in net interest margin. We expect mortgage rates to increase alongside the RBA cash rate while interest on deposits will lag. Insurers will start to roll short-term investments to higher rates.
  3. Dividends – ANZ Bank’s results delivered an interim dividend of $0.72 per share (2.6% cash, 3.8% grossed up) for the half-year. Whether or not the banks pass-through rate rises to deposit holders, investors can still find good yields across a range of Australian equity market sectors. Share prices are volatile but they provide long-term growth to counter the effects of inflation while bank deposits and term deposits simply do not.

What should investors be on the lookout for?

Look for companies that are going to miss expectations when they provide an update for investors ahead of any formal results announcements in the August reporting season.

Companies tend to pre-position weak results in the two months to June 30, leading to a slew of downgrades. The next two months will be critical for investors as a shift from ‘great expectations’ to ‘clear explanations’ gets underway. The chart below shows that, on average, 70% of all downgrades in a calendar year at announced before the end of the financial year. It will be these events that investors need to be on the watch for in the coming weeks.

Specific issues facing Australian companies are inflation, increased costs for businesses - especially from energy and wage pressure - and the ongoing pandemic lockdowns in China resulting in supply chain disruptions with our biggest trading partner.

The recent US reporting season is a good case in point. It saw approximately every three out of four companies meet or beat expectations, but the high growth names still struggled as their results were lackluster. High valuation, high expectation stocks in Australia are at risk of price falls if they fail to meet their targets.

Concerns and opportunities

The good (Wisetech and Altium) and the bad (Tyro Payments, Megaport and Zip Co).

Revenue growth in the technology sector is on track but profitability on incremental growth continues to disappoint. TYR, MP1 and ZIP have been significantly de-rated and will need a major catalyst to revert in the near term. Low prices could make them takeover targets, but profitability still seems a long way off.

We prefer global logistics giant Wisetech and circuit board design software firm Altium. Both companies have de-rated since January but nowhere near the falls which have beset Tyro Payments TYR, Megaport MP1 and Zip Co ZIP. Our metrics point to potential upside in their next results, which should at least provide support for their current price.

Altium is now back to where the company had originally been bid for in mid-2021. There is still room for growth, as the design of appliances evolves, requiring a redesign of internal circuit boards. Altium’s software is a market leader in this area, and we see the potential for incremental improvements in profitability: an expected 25% increase in revenue over the next two years is expected to grow earnings-per-share (eps) by 50%.

When it comes to discretionary spending and travel, tighter purse strings may well flow through to a cutback in spending. Here we like JB Hi-Fi.

We see concerns with Domino’s Pizza DMP as the consumer seeks to reengage outside of home dining, and some uncertainty still lingers over travel demand which will impact Flight Centre FLT, Qantas QAN and Corporate Travel CTD.

We still like JB Hi-Fi and believe that its valuation is factoring in too large a contraction in revenues. Pre-Covid-19, the stock traded at a high of $45. Even with earnings contracting in the next two years, the company is still set to deliver 50% higher profitability, but its share price is only 10% higher than its pre-Covid peak. JBH gave a Q3 sales update on 4 May, highlighting heightened customer demand and strong sales growth which were up 11.1% year-on-year. There are potential short-term headwinds with no guidance being provided with their latest sales update, due to ongoing global supply chain uncertainties, but there is a solid, profitable underlying business here with a strong market presence.

Beware the ‘gap’

Rising equity market volatility is typically a ‘down-side’ phenomenon. If we consider the market price when the number of large 1-day moves (plus or minus 1%) increases, we note the market is almost always off its highs. We are seeing this now; the ASX200 has moved by 1% or more in 15 of the past 60 days, and the local market is 3% off its highs. If we continue to see more frequent large daily moves, we expect that this will coincide with the marketing drifting lower overall.

That said, the Australian equity market is well placed with its commodities exposures, financials and lower (against the US) exposure to stretched growth valuations. A focus on better valuation stocks in favoured sectors, which have a strong market position and solid profit margins, are likely to weather volatility well. This is also aligned with companies that have strong cash flow to support dividend payments, and in 2022, a focus on this type of yield stock has outperformed.

Successful equity investing has much to do with buying well. Investors should be increasing their focus on the market over the rest of 2022 and avoid being turned away by the volatility. History has shown over and over that share prices are far more volatile than the underlying profits and dividend payments of companies. The normalising of interest rates across the globe is an event that also raises uncertainty which will play out as higher share price volatility and, most likely, lower prices overall. This will lead to good investment opportunities today and as monetary and fiscal settings are reset over the next year.

 

Max Cappetta is a Portfolio Manager and CEO at Redpoint Investment Management. Redpoint is a specialist investment manager partner of GSFM Funds Management, a sponsor of Firstlinks. The information in this article is provided for informational purposes only. Any opinions expressed in this material reflect, as at the date of publication, the views of Tribeca and Redpoint and should not be relied upon as the basis of your investment decisions.

For more articles and papers from GSFM and partners, click here.

 


 

Leave a Comment:

RELATED ARTICLES

Why August company reporting season was poor

Dividends, disruption and star performers in FY21 wrap

Key themes from reporting season, and what's next

banner

Most viewed in recent weeks

Are LICs licked?

LICs are continuing to struggle with large discounts and frustrated investors are wondering whether it’s worth holding onto them. This explains why the next 6-12 months will be make or break for many LICs.

Retirement income expectations hit new highs

Younger Australians think they’ll need $100k a year in retirement - nearly double what current retirees spend. Expectations are rising fast, but are they realistic or just another case of lifestyle inflation?

Welcome to Firstlinks Edition 627 with weekend update

This week, I got the news that my mother has dementia. It came shortly after my father received the same diagnosis. This is a meditation on getting old and my regrets in not getting my parents’ affairs in order sooner.

  • 4 September 2025

5 charts every retiree must see…

Retirement can be daunting for Australians facing financial uncertainty. Understand your goals, longevity challenges, inflation impacts, market risks, and components of retirement income with these crucial charts.

Why super returns may be heading lower

Five mega trends point to risks of a more inflation prone and lower growth environment. This, along with rich market valuations, should constrain medium term superannuation returns to around 5% per annum.

Super crosses the retirement Rubicon

Australia's superannuation system faces a 'Rubicon' moment, a turning point where the focus is shifting from accumulation phase to retirement readiness, but unfortunately, many funds are not rising to the challenge.

Latest Updates

Investment strategies

Why I dislike dividend stocks

If you need income then buying dividend stocks makes perfect sense. But if you don’t then it makes little sense because it’s likely to limit building real wealth. Here’s what you should do instead.

Superannuation

Meg on SMSFs: Indexation of Division 296 tax isn't enough

Labor is reviewing the $3 million super tax's most contentious aspects: lack of indexation and the tax on unrealised gains. Those fighting for change shouldn’t just settle for indexation of the threshold.

Shares

Will ASX dividends rise over the next 12 months?

Market forecasts for ASX dividend yields are at a 30-year low amid fears about the economy and the capacity for banks and resource companies to pay higher dividends. This pessimism seems overdone.

Shares

Expensive market valuations may make sense

World share markets seem toppy at first glance, though digging deeper reveals important nuances. While the top 2% of stocks are pricey, they're also growing faster, and the remaining 98% are inexpensive versus history.

Fixed interest

The end of the strong US dollar cycle

The US dollar’s overvaluation, weaker fundamentals, and crowded positioning point to further downside. Diversifying into non-US equities and emerging market debt may offer opportunities for global investors.

Investment strategies

Today’s case for floating rate notes

Market volatility and uncertainty in 2025 prompt the need for a diversified portfolio. Floating Rate Notes offer stability, income, and protection against interest rate risks, making them a valuable investment option.

Strategy

Breaking down recent footy finals by the numbers

In a first, 2025 saw AFL and NRL minor premiers both go out in straight sets. AFL data suggests the pre-finals bye is weakening the stranglehold of top-4 sides more than ever before.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.