February 2017 results season: Profit improvement expected
The February results season will signal a return to profit growth in aggregate by Australian companies.
We are expecting a gain of between 16% and 17%. It's the aggregate number that counts for a broad-based share market investor, rather than individual company results.
The big change this time compared to recent years, when aggregate profits have fallen, is the resources sector turnaround. Over the last few years, commodity prices have dropped, leading to very sharp falls in resource sector profits.
This has now reversed: the oil price has more than doubled, gold is up and so are energy prices. So we are expecting a strong turnaround in profits, led by the resources sector.
The flip side, however, is that profits are constrained outside the mining sector. It’s likely more muted growth of about 5% is likely for non-mining company profits.
Retailers, utilities and building materials companies will lead the charge. A relative laggard will be banks, whose profits retreated last financial year. They may not go backwards this financial year but they will be fairly soft. So investors who have been relying on banks to generate returns may continue to be disappointed.
Slow credit growth is the main problem for banks, with demand for credit declining as the housing market has slowed. At the same time there has been pressure on banks’ balance sheets to hold more capital, which has meant costs have risen at the same time as revenue growth has slowed.
The high Australian dollar is the other drag on companies with exposure to the US dollar or global markets. Over the last year the dollar has traded in a range below US$0.70 cents to around US$0.76 cents now.
In the very short term the dollar could display a bit more upside if the US dollar continues to correct, following its huge rally last year partly inspired by the election of Donald Trump.
But the US dollar’s value has probably gone a bit too far now and if the greenback declines the Aussie dollar will benefit. But the likelihood is we will see the Aussie dollar back below 70 cents by year’s end.
This is because the US is likely to raise interest rates this year, whereas the Reserve Bank of Australia is likely to hold or cut rates. So we will see a narrowing in the interest rate differential, which is traditionally negative for the currency. Negative GDP growth in the September 2016 quarter and generally low inflation could build a case for a rate cut later this year.
Nevertheless, recent inflation figures are probably not low enough to trigger an imminent rate cut. Additionally, further rate cuts could continue to boost the already hot housing sector, one reason the central bank may hold off making another cut.
The other factor the central bank will take into consideration when making interest rate determinations is that, even though commodity prices have bounced back and that's helped the Aussie dollar stabilise over the last year, they are unlikely to appreciate substantially further. They are more likely to track sideways, which will be neutral for the currency.
However longer-term, given many analysts haven't factored in current commodity prices, there could be further profit improvements for resource sector companies in the short-term.
But as we go through the year expectations for the resources sector will run their course and investors will be thinking: what next? We anticipate underlying growth in the Australian economy will pick up after profit weakness in the second half of 2016.
Donald Trump’s presidency is the unknown factor. Last year was characterised by uncertainty with Brexit and Trump, and even locally with a messy election result. Yet market returns were positive.
Bear that in mind when assessing Trump. What he says and does might not necessarily have a lasting impact on the markets. Take some of the things he says with a grain of salt; take them seriously but not necessarily literally.
Overall, markets are likely to remain volatile. We've seen a massive rally, but now the Trump honeymoon is over. Nevertheless, the upcoming profit season should be positive for local self-managed super fund investors.
About the author
Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital, is responsible for AMP Capital's diversified investment funds. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.