Earnings season FY17 mixed bag so far

Glenn Freeman | 18/08/2017

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Glenn Freeman: I'm Glenn Freeman for Morningstar, and I'm joined today by Shane Oliver, chief economist with AMP Capital.

Shane, thanks for joining us today.

Shane Oliver: It's a pleasure to be here.

Freeman: Now, Shane, just firstly, back in April, you said you didn't see Australian companies as particularly cheap nor were they overly expensive. Is this still the case?

Oliver: It's pretty much still the case. I would regard the Aussie share market is around fair value. If you look at traditional metric of the price to earnings multiple, it's a little bit above fair value. If you look at indicators which allow for the low level of interest rates, low bond yields, it's a little bit cheap, little bit under fair value.

So, on that basis, I'd say, it's in the ballpark of around fair value as things currently stand. And oddly enough, for much of this year, the last few months or so, we've really just been bouncing up and down, and that's perhaps partly an indication that investors are finding it hard to find undervaluation or overvaluation.

Freeman: And we're now around halfway through the annual earnings season. What's your take so far?

Oliver: I guess it depends on how you assess it. If you look at the number of companies surprising on the upside and good news stories coming out, I'd say it's a mixed bag. There's actually been slightly less companies surprising on the upside than it was, say, back in the February reporting season. So, that's a bit of a disappointment. And there have been some high-profile misses in there.

Flipside though, is that profits are up roughly 18 per cent over the last financial year. A big driver of that, of course, is the resources sector where profits are up about 130 per cent, 135 per cent on the back of the surge in commodity prices.

And of course, if you strip them out, profit growth in the overall market excluding resources is around 5 per cent, 5.5 per cent. So, in that sense, it's sort of okay. Profits have gone from a situation of two consecutive years of declines to an environment where they're now rising again.

The other thing, of course, is that if it's dividend you're after, then you're still seeing increases in dividends. So, not only are profits up, but companies are paying out more dividends. About 80 per cent of the companies have increased their dividends on my count so far. So, mixed bag, but good news is that profits are up and the dividends are continuing to rise.

Freeman: In terms of currency, how much of a risk does the rising Australian dollar pose for the Australian economy and how can local investors position themselves in this regard?

Oliver: I think the rising Australian dollar that we've seen over the last month or so, where we sort of pushed up above $0.80 at one stage, that is a bit of a concern for the local economy. We're still in an environment where mining investment is still falling. Sometime over the next year housing construction will start to top out and that will become a bit of a drag on the economy as housing construction starts to slow down. And consumer spending is a bit subdued for a whole a bunch of reasons, low wages being the most well-known of one of those reasons. But all of those things just be still need help from a lower Australian dollar to drive sectors like tourism, manufacturers who are still with us, and higher education, in other words, to boost the competitiveness of the Aussie economy. So, if the Aussie dollar starts going up, that could actually be a bit of a drag on the Australian economy.

How should investors play this? I guess, what the Aussie does is very important for investors. Not only does it affect the performance of the Australian share market and Australian companies that are affected by moves in the currency, but also affects your investment overseas. Given my view that the Aussie dollar will tend to go down rather than up over the next 12 months because I think the Reserve Bank is still set to leave interest rates on hold, whereas the Fed is more likely to raise them. So, we are going to see this continuing narrowing in interest differential between Australia and the U.S. which works against the Aussie dollar. So, given that view, the Aussie dollar, I think, will more likely fall rather than rise. It still makes sense for investors to have a decent exposure to offshore assets, offshore shares, for example, and do that on an unhedged basis. So, I think, that's the key message in terms of the currency for investors at present.

Freeman: We hear a lot about passive investing and that's for all types of investors, including for SMSF trustees. Do you see this as something of a shorter-term trend or is a long-term shift?

Oliver: I think the shift towards ETFs is part of a long-term shift. It reflects the evolution of investment markets, but it's also partly cyclical. But I think as we move into a world where eventually interest rates start to rise again, that could bring active management back into vogue and therefore, this shift towards ETFs, passive ETFs, in particular, will take a bit of a pause. So, yes, it's a part of a long-term trend, ease of access, lower fees and lower costs, those sorts of things, but there's also a cyclical aspect to this and I think at some point that cycle will swing back the other way and active management will come back into favorite for a while.

Freeman: And lastly, property is also always in the mix for SMSF trustees. You said around a year ago that you're favoring commercial property over residential. Is this still your view?

Oliver: My view on property hasn't changed. A year ago, I favored commercial property over residential because I thought commercial offered high yields, that's the basic – or the rental yield you get or the income flow you get from that investment, high yield compared residential property. And the main reason there was because residential property prices have been pushed through the roof in Sydney and Melbourne. And so, if always the prices have gone up, rents haven't kept pace and the rental yields have gone down. Whereas commercial property, values have gone up but nowhere near as much and that's left the rental yields looking relatively more attractive. And that remains the case. So, I'd still favor commercial over residential.

But of course, there's pockets of the residential market. I was probably a bit too early a year ago saying that commercial was the place to be. Residential, if you invested in Sydney and Melbourne would have still outperformed commercial, although commercial has done pretty well over the last 12 months. But I do worry that the Sydney and Melbourne property markets have become a bit too hot that I know – we've been saying this for many years now, but sooner or later, particularly with the Sydney property market up 70 per cent-odd over the last five years, the Melbourne market up nearly 60 per cent over the last five years, sooner or later there will be a cooling down of those markets and the money will flood somewhere else.

Freeman: Thanks very much for your time today, Shane.

Oliver: My pleasure. Thank you.

Freeman: I'm Glenn Freeman for Morningstar. Thanks for watching.

This report appeared on www.morningstar.com.au 2017 Morningstar Australasia Pty Limited

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