Australia’s stock market has just recorded its worst monthly performance since the pandemic began, and investors are bracing for more pain ahead with broader earnings downgrades in the offing.

The benchmark S&P/ASX 200 index was down 13% in the first half of 2022, with a majority of the losses — over 8% — in June alone.

According to Morgan Stanley research, 43% of the companies on the ASX300 are yet to revise their earnings guidance which are now 80 days or older, despite dramatic changes in the macroeconomic environment since then.

“The valuation signal is more reasonable versus the beginning of the year - what muddies the water is that earnings have yet to adjust to a weakening outlook,” Morgan Stanley Australia equity strategist Chris Nicol said in a recent note.

That raises the risk of share price falls for local investors ahead of the so-called ‘confession period’ over the next few weeks, when companies update earnings guidance before announcing results in August.

If share price moves that followed a handful of earnings downgrades recently are any indication, that adjustment could prove painful.

Shares in Origin Energy (ORG) sank 15% after Australia's second biggest power producer slashed its guidance in early June. Gold miner Evolution Mining (EVN) slid more than 20% after forecast lower production and higher costs, while an earnings downgrade resulted in a 40% wipeout for beauty products maker BWX Ltd (BWX) last week.

Margin pressure

Other companies that have revised their earnings estimates downward include top utility AGL Energy (AGL), miners Dacian Gold (DCN) and Oz Minerals (OZL), retailer Universal (UNI), healthcare operator Healius (HLS) and industrial equipment manufacturer GUD Holdings (GUD). Their varied nature suggests the pain is being felt across a range of sectors.

“The combination of higher energy prices, rising wages costs and supply chain issues means it is very difficult for any company to really maintain margins,” says Peter Warnes, Morningstar’s head of equities research.

“All operating costs have increased and some of those costs are now deeply embedded in their operations.”

Indeed, food and grocery wholesaler Metcash (MTS) last week noted that about 60% of its suppliers have sought price increases amid rising input costs.

The IGA Supermarkets operator delivered record sales and an improved full year profit but says it is considering a number of options to limit the impact of price increases and keep its products competitive.

That could prove difficult with Reserve Bank Governor Philip Lowe predicting that inflation is likely to hit a 32-year high of 7% before the year ’s end.

The central bank’s cure to tamp down on the runaway prices - by lifting interest rates rapidly - is proving to be as difficult a problem.

Even so, the ASX has been spared the steeper selloff seen overseas.

The Australian benchmark’s 13% drop in the first half of 2022 compares with the tech-heavy Nasdaq that has slid 30% over the same period. The US benchmark S&P 500 is down 21% and the Euro Stoxx 50 has lost 20%.

The reason for the ASX’s relative resilience is the higher weightage of resources stocks which have performed solidly, though the outlook for mining firms has also started to deteriorate.

Growing worries about aggressive rate hikes by central banks and the inevitable slowdown in global growth that is widely expected to follow will likely hit demand for key steel-making ingredient iron ore — Australia’s top export.

“Despite the fact that commodities have been strong performers so far, we think higher costs and labour shortages will mean a drop in output and that means earnings will likely slow down on the horizon. And we are probably going to see some disappointing numbers,” said Jessica Amir, market strategist at broker Saxo Capital Markets.

Interest rate sensitive sectors such as banks, property and information technology are also vulnerable to downgrades and share re-pricing, analysts say.

“Earnings are now on course to follow equity prices lower, and it appears as though we now have to assume that we will be facing cuts to earnings estimates through to early next year,” UBS strategist Richard Shelibach said in a note this week.

He is forecasting for earnings to fall by an average 20% over the coming six months, and has cut his ASX 200 price target by 10% to 7000 points. The market closed 2021 at 7444.