The recent reporting season can only be described as a whirlwind of volatility. Markets experienced substantial fluctuations, a sector rotation may have begun, and the overall sentiment was one of caution and uncertainty. However, amidst this backdrop, there are still growth opportunities for investors.
In one word, it was volatile.
Volatility was the name of the game, with significant market movements observed on the day companies announced results. We saw earnings estimates downgraded by around 1.7% and approximately 16% of companies that reported have seen a move of plus/minus 10%, with 60% of these moves being on the downside. This was a stark contrast to the previous reporting season, where only 10% of companies experienced such dramatic shifts, and the split between up and downside moves was more balanced.
One of the primary drivers of this volatility was the disparity in results across different sectors and market caps. For instance, the insurance sector saw significant divergence between companies like QBE and IAG, while the banking sector witnessed notable differences between CBA and Bendigo Bank. The retail sector also experienced substantial variations, with Harvey Norman and Super Retail showing contrasting performances.
Macro uncertainty
Several macroeconomic factors contributed to the heightened volatility, with geopolitical uncertainty dominating. Trade tensions and tariffs threatened global growth, and the retaliatory tariffs between the US and other nations, particularly China, created an environment of unpredictability, impacting sectors exposed to global trade. Mining, which accounts for a significant portion of Australia's GDP, was particularly affected by these uncertainties.
China's economic outlook also played a significant role, with the country slowly inching towards more stimulus measures to stabilise its economy. Property prices in China have started to stabilise, particularly in tier one and tier two cities, and consumption seems to be improving. The Chinese government's commitment to a GDP target of 5% and additional fiscal spending of $3.6 trillion Renminbi indicate a cautious yet supportive approach to economic growth. This incremental stimulus could have substantial implications for global markets, especially for sectors heavily reliant on Chinese demand.
Interest rates were another critical factor influencing market sentiment. The Reserve Bank of Australia (RBA) cut rates for the first time in three years, prompting a positive response in property prices and sectors linked to the housing cycle. Companies like Harvey Norman and Temple & Webster reported solid outlooks, benefiting from the rate cut and a more favourable housing market.
Tech: A surprise bid
The tech sector, known for its high beta, experienced significant volatility during the reporting season. Large-cap tech stocks were trading at expensive valuations compared to their smaller and mid-cap counterparts. However, the reporting season provided an opportunity for smaller-caps to deliver positive updates and re-rate closer to their larger peers. Companies like WiseTech faced corporate governance concerns, impacting their performance.
Additionally, we saw a surprise bid by CoStar on number two real estate classifieds player Domain. While this saw us trim our position, more broadly it makes classifieds like SEEK, REA, and Car Group more attractive on the basis of the implied multiple for those businesses, particularly as the number one players in their verticals.
Banks: Weaker growth
Banks saw a sharp correction in valuations, with mixed results across the sector. CBA reported strong numbers, but Westpac, ANZ, NAB, and Bendigo delivered weaker results. The sector's performance highlighted the disconnect between valuations and fundamentals, with anaemic growth and long-term declining returns coming to the fore. This reporting season underscored the sensitivity of bank valuations to changes in sentiment.
Mining: Cost inflation, reinvestment cycles and rotations
The mining sector contributed its fair share of volatility this reporting season. Significant one-day moves were observed, such as Blue Scope rising by 13% and Mineral Resources falling by 20%. Overall, the sector experienced net downgrades for the sixth consecutive reporting season, contributing to a 3% decline for the month compared to a 4% drop in the broader market.
The primary driver for these changes was the decline in commodity prices, including iron ore, coal, nickel, and lithium, with gold being a positive outlier. These price declines led to earnings downgrades across the sector.
We saw three key themes emerge: cost inflation, CAPEX reinvestment cycle and the signs of a general rotation from banks to miners.
Cost inflation remains an issue despite peaking post-COVID. While inflation in diesel, energy, and refining costs has lessened, labour costs continue to pressure margins for miners, keeping overall inflation around 4%.
We are seeing major players like Rio Tinto and BHP enter a reinvestment cycle, focusing on offshore copper and lithium projects. This has resulted in elevated CAPEX, rising from $5-6 billion a decade ago to $10-11 billion today, leading to increased net-debt and lower dividends with BHP reporting its lowest dividend in eight years, and Rio in seven.
The beginning of a possible rotation from banks to miners benefited the mining sector despite the overall net earnings downgrades. As China's economy shows signs of stabilisation with incremental stimulus measures and a renewed focus on achieving a 5% GDP growth target, the demand for commodities could see a resurgence given its significant exposure to China. While banks have been beneficiaries of domestic investment and relatively stable returns, the potential for a sector-wide rotation to mining is supported by the undemanding valuations in the mining sector and the strategic importance of Chinese economic recovery.
Outlook
Going forward, regardless of market volatility and uncertainty, we do see growth opportunities for investors if they know where to look.
In tech, we are seeing opportunities driven by strong structural tailwinds that support long-term growth. Unlike other sectors, tech companies are not entirely decoupled from broader macroeconomic trends. However, their innovative nature helps to provide resilience through various market cycles. Classified companies such as SEEK, are more cyclical and exposed to fluctuations in volumes. They have for the first time shown recent signs of stabilisation, providing a glimmer of optimism. Additionally, Car Group, as the number one player in its vertical, has strong growth opportunities and looks relatively cheap given its implied multiple versus Domain, which is a number two player, revealing the possibility of more interesting opportunities in the M&A space.
On the other hand, software companies such as WiseTech, Xero, and TechnologyOne are being propelled by product-led growth.
The mining sector, with its undemanding multiples, could benefit from any recovery in Chinese demand. The sector's exposure to global trade uncertainty and cost inflation challenges should be carefully monitored, but opportunities exist, particularly in companies well-positioned for a potential stimulus-driven recovery in China.
However, threats of a trade war may provide headwinds for the mining sector and the flow on effect for the broader economy. A Chinese retaliatory stimulus response could offset potential headwinds and benefit Australia and Australian miners disproportionately. Investors looking for growth opportunities may find the mining sector's current landscape more appealing, particularly if the anticipated recovery in China materialises, offering a counterbalance to the stretched valuations and subdued growth outlook in the banking sector.
Amidst the volatility and uncertainty, growth opportunities still exist for discerning, active investors. Investors must navigate this landscape with a keen eye on macroeconomic trends, sector-specific dynamics, and individual company performance. By staying informed and adaptable, investors can uncover growth opportunities even in the most volatile conditions.
