Four big questions for markets as the free money era ends

Hans Lee

Livewire Markets

After four weeks and nearly 160 reports, we have finally made it to the end of the August reporting season. This year's full-year reports were littered with commentary on the state of the global economy. The long shadow of COVID-19 has created a slew of issues for companies to contend with - including but not limited to - supply-chain challenges, underinvestment in infrastructure, and labour shortages. 

In spite of all those headwinds, corporate balance sheets are looking healthier than some may have first feared. CommSec crunched the data on corporates and found that 63% of companies were able to increase profits in the 2021/22 financial year. 

Dividends are continuing to be paid out - not least by the Big Three iron ore miners. BHP Group (ASX: BHP) alone will pay out a $23 billion dividend next month. The other two majors Fortescue (ASX: FMG) and Rio Tinto (ASX: RIO) both cut their dividends but will still pay out chunky sums. In contrast, the Big Four banks held back on their payouts - a move that has proved to be prudent as its smaller counterparts Bendigo and Adelaide Bank (ASX: BEN) and Bank of Queensland (ASX: BOQ) struggle to remain competitive on net interest margins.

But markets are forward-looking, and as the free money era rolls over, investors are casting a long and cold eye over the outlook. In my mind, four questions remain: 

  • Are we at the peak for dividends in this cycle?
  • Will crimped margins be an FY23 and beyond issue?
  • How long will increased costs linger?
  • When will skilled labour shortages ease?

To answer some of those questions (and a few more), I sat down with James Gerrish from Market Matters for a post-reporting season deep dive discussion. In the following video, you can expect:

  • A discussion on outlook statements
  • A comment on the future of corporate margins
  • The forecast for dividends
  • James' favourite and least favourite company picks from reporting season

This interview was recorded on Thursday, 1st September 2022. 


Hans Lee: Hello, I'm Hans Lee from Livewire Markets and welcome to our post-reporting season sit-down interview. To take us through all the beats, the hits, the misses, and most importantly what happens now, I'm very pleased to say we are joined by James Gerrish of Market Matters. Thank you very much, James, for joining us.

James Gerrish: It's a pleasure to be here, Hans.

Hans Lee: I want to draw on something that you spoke to me about six weeks ago when we did our pre-reporting season chat. You said two words would define the August reporting season, specifically variance and uncertainty. Is that still the case?

James Gerrish: Yeah, I think it is. I think you reflect back on those comments and it's probably a little bit of a cop-out in terms of picking those two words. Most reporting seasons are going to be dictated by those two trends. I think in terms of variance, one of the things we've seen is some big differences within underlying sectors. If I use retail as an example, some retailers doing particularly well and others doing particularly poorly. I'd cite Lovisa (ASX: LOV), Wesfarmers (ASX: WES), Nick Scali (ASX: NCK) doing particularly well. Super Retail Group (ASX: SULyou could throw in there as well. And you contrast that to a City Chic (ASX: CCX) which has done particularly poorly. 

Variance within sectors and banks, for instance, is another example. The Big Four are doing better than the regionals in terms of their margins and outlook going forward. In terms of uncertainty, I would put it on a quantum. I come into reporting and because of the variable conditions we've had moving into it, a lot of moving parts going into this reporting season. There wasn't a lot of certainty there. 

I've come out of reporting season, I'm probably a six to seven. Normally I'm probably a seven to eight in terms of how certain we are on the outlook. Yeah, I think that's improved, but those two things still stack up. Those two words still stack up.

Hans Lee: You definitely talk about the banks as a basket case, as well as the retailers. I think of companies like Sonic Healthcare and Healius that didn't provide an outlook because of its uncertainty because COVID is still very much the elephant in the room. What do you think that all say about the state of the corporate recovery outside of the pandemic?

James Gerrish: I actually think banks are in very good shape. I think they've proven to be very resilient and I think they're in, from speaking to banks and what management is saying about the health of the Australian economy, I think we can be pretty encouraged around that. You made mention of just the retailers again, and I'll touch on that because the consensus was so negative, the retailers going into this reporting season. Everyone you spoke to is don't be in consumer discretionary stocks. They've actually done better overall than what the market had feared. You've highlighted Sonic Healthcare (ASX: SHL) and Healius (ASX: HLS), they're very much at the pointy end of the COVID trade if you like. They're involved in pathology, they had a great bump up in earnings during COVID. I think coming out the other side, there is still what I've seen from COVID-related influences on earnings this year has been a big bump up in the second half.

There's been this huge pent-up demand that's played out in the second half in some areas of the market. Balance sheets have also been quite good. I was looking at a company recently that was in IVE Group (ASX: IGL). They're an integrated marketing business, right at the pointy end of the Australian economy, if you like, spending money on marketing. They were nearly out the back door during COVID. They're now up tenfold and they're doing better than they ever have. I actually think corporate Australia is okay. There are a few pressures out there. There's no doubt about that, but I think we're coming out of this reporting season saying that we're in reasonable shape.

Hans Lee: Let me play devil's advocate to that then. I mean, you just look at the slew of outlook statements, you can see all these key themes developing. I think of rising interest rates, I think of competition for labour, supply chains and some of those things are still not necessarily resolved. Do you feel you've got enough clarity from companies about these key headwinds?

James Gerrish: All of those key points that companies speak about, I put it into buckets that are known knowns and variables or unknown knowns. I think interest rates are well and truly known and understood. We're seeing some impact of rising interest costs and the like in company results, but if you cast your mind back 12 months ago, Aussie three-year bonds were 20 basis points. They're now 330. That's a 16-fold increase in bond yield. 

We've experienced that, that rate of change has been as high as it probably is going to be. In terms of labour pressures, that's been the key point coming out of this reporting season. I'd put it in the bucket of unknown knowns. 

I don't know how that's going to play out. Tight labour markets have got to be inflationary. The extent of that is going to be a key factor over the next 12 months. In terms of supply chains, you've probably seen some easing in the supply chain. That was an issue six months ago. I think probably some of that has eased a little bit from what I understand from companies reporting. From an investment standpoint, you've got to look forward. We're hearing about how companies and all the issues they've had over the past 12 months, you've got to try and mould that into your thinking for the next 12 months. Not just think it's all doom and gloom.

Hans Lee: You alluded to the balances and the strength of balances, despite all the things that are happening. Were you surprised by how resilient corporate margins were this past month?

James Gerrish: Margins are a big one. That was a concern going into this reporting season. You had all these rising costs, and input costs, and then you had a consumer that was battling with higher interest rates, falling house prices, low consumer confidence and the like. What we've seen though is generally margins hold up. That pricing, so corporates have been been able to pass on that increase in input costs to higher prices. That's ultimately feeding inflation and the like, but because everyone's got a job because everyone is earning good money and wages are rising, then for now they've sucked up those higher costs. 

The real challenge will come in the next 12 months, as things tighten further and whether or not we can continue to handle those rising input costs. I'd say on the other side though, as well, if all these things do ease off a little bit, if we have some easing in the supply chain, if we have labour markets easing off a little bit, a lot of companies, a lot of producers, a lot of retailers and the like have increased the prices they're charging. 

They're not going to wind those back. They're not going to reduce those prices. Then the optimist would say, you can then have an expansion in margins at some point down the track. It's a two-edged sword, if you like, Hans.

Hans Lee: What do you make of the dividend landscape? If I can pose to you, James, I was just reading a wonderful stat from CommSec, something like a quarter of dividend payers actually cut their payouts this past month. Then you contrast that with companies like BHP and Fortescue who are making more money than they know what to do with. Is this as good as it gets?

James Gerrish: Probably in mining. I would think that mining is probably peak earnings and peak dividends. I think if you're forecasting dividends for that area of the market moving forward, you're probably factoring in lower levels. In terms of the broader space, banks are big dividend payers, but their payout ratios are lower than they have historically. They're in good shape. If the Australian economy gets through better than feared, then they'll start ramping that up again. Property was an interesting one. Property is traditionally a really great dividend-paying sector. 

Some of the assumptions around FY23 interest rates and the like have filtered into lower guidance around dividends. That has been an obvious theme playing out in the property space. Look, dividends, they're a huge part of the returns you get from investing. They're important and the dividends that are coming from the miners, I think you need to be quite cautious on going forward.

Hans Lee: I want to draw on something else you said in our last discussion. We were chatting about the bar for expectations and whether they've been set too high, but what I'm curious from your end and you have access to all the research and all the analysts and what they say, what do you make of all the broker moves in the wake of these results? And a lot of them are downgrades.

James Gerrish: Yeah, they are. There weren't a lot of moves pre-reporting. And I think that's because there was a bit of an information vortex leading into it. There were a lot of moving parts. Analysts didn't have a handle on it... Companies didn't have a great handle on it, so analysts didn't either. We've gone into a downgrade cycle is the first thing to say. And generally, a downgrade cycle lasts for six months plus, so expect continued downgrades probably into the first part of calendar '23. In terms of the quantum of downgrades, so the ASX 200 over time, over the last 20 years, it grows earnings by 5.5% a year per annum on average. 

James Gerrish: A month ago, we were forecasting earnings growth of 8.2%. That was coming off 20% in FY22. Another 8.2% in FY23 was forecast. Those expectations have been tempered down to about 6.5%. If you think about the average over the last 20 years, 5.5% earnings growth and the headwinds and the variable conditions, what all the corporates are dealing with, you'd expect further downgrades to earnings in aggregate. I expect further downgrades. I think the market does as well. I don't think that'll come as new news, but for now, stock prices are, or the index level at least sort of sucking those up.

Hans Lee: I want to finish off if I can, with a little bit of a rapid fire round. Three quick questions and three relatively quick answers. If you could nominate one company, biggest single best surprise.

James Gerrish: That we own? Altium (ASX: ALU). Cracking result for FY '22, guidance for FY '23 was phenomenal. And I think conservative, so Altium.

Hans Lee: Biggest single worst surprise?

James Gerrish: Service Stream (ASX: SSM). And I flagged this one six weeks ago to you that I was concerned going into this result because they've got a lot of staff and a lot of complexity in their business. Their revenue was a beat, their earnings were a miss because margins are under pressure. A poor result for mine. Hopefully, the guidance they provide in October gives us something to hang our hats on.

Hans Lee: Are you still holding onto Service Stream?

James Gerrish: Yeah, we are.

Hans Lee: Okay. And one word here. After all, are you now more optimistic or pessimistic about the state of the equity market?

James Gerrish: I'm generally an optimist and I think you've got to be in the equity market. That's why we go into equities. The pessimists go into the bond market. I'm optimistic. I wouldn't be surprised though if we see some ... The market has rallied sort of 9%, 10% from the lows. I wouldn't be surprised to see a bit of a vortex at the back end of reporting where the market tracks lower. But again, that presents an opportunity to set portfolios and buy great stocks for the next 12, 24, and 36 months.

Hans Lee: James Gerrish, thank you very much.

James Gerrish: Thanks, Hans.

Hans Lee: And thank you for watching. We hope you enjoyed that. If you did, do subscribe YouTube channel, give this video a like, and of course do consider joining the website, On behalf of all of us, see you next time.

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Hans Lee
Senior Editor
Livewire Markets

Hans leads the team's coverage of the global economy and fixed income. He is the creator and moderator of Signal or Noise, Livewire's multimedia series dedicated to top-down investing.

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