Local, global economies will run “hot” for some time, with the support of policymakers.

The economy: Ausbil v consensus outlook

Source: FactSet, Ausbil, 2021, (f) = forecast

Risks

There are several risks to Ausbil’s outlook. Recently, markets have been concerned about a permanent rise in inflation; what the recent rises in bond yields might mean for more persistent inflation; and the risk posed to interest-rate levels.

There also remains unquantifiable geopolitical and trade risks around the world, including the potential for regional conflicts in Iran/Israel, China/Taiwan, Russia/Ukraine, and now with actual conflict in the Middle East.

Ausbil’s view is that economies will run “hot” for some time, with the support of policymakers, and are delivering the best growth figures since 1983, across a multi-year growth profile, as illustrated in the table above.

Although inflation will remain an ongoing source of worry as the perennial flipside to growth, it is important to understand when inflation spikes are intermittent or if they are moves to a higher sustained level. It is our view, and indeed that of most global central banks, that inflation will not be a problem for some years as the world economy returns to health.

We see inflation remaining within target ranges for some years, and cash rates on hold until 2024, with long-bond yields to adjust over these years in an orderly fashion.

Australia’s economic growth, and the current resources boom, will underpin the Australian dollar, with Ausbil forecasting the AUD/USD in an up-trend: 75-80c for 2021, 80-85c in 2022, and 85-90c in 2023.

This low-rate environment, and the multi-year economic growth outlook, are supportive of an underlying multi-year growth outlook for equities, especially in cyclical sectors, banks, and resources as world demand grows.

Banks, resources to lead earnings surprises

(Editor’s note: Do not read the following ideas as stock recommendations. Do further research on your own or talk to a financial adviser before acting on themes in this article).

Two key sectors where we see further earnings surprises are banks and resources.

Banks, which offer primary exposure to a recovering economy, entered the pandemic after a heavy barrage from the Hayne Inquiry and having already been sold down.

The pandemic saw them sold down further on fears that the recession and Covid job losses would affect their lending books. All the banks made major provisions for the potential of credit loss, and the Australian Prudential Regulation Authority (ARPA) further enforced capital retention by limiting the dividends they were allowed to pay.

Looking at the banks in the 2021  new financial year, it was evident that the bad and doubtful debt experience was nowhere near predictions,  and that the banks had over-provisioned for losses.

With APRA allowing a return to more commercial dividend levels, and the economy resurging from the 2020 lows, we could see banks were in a position to reduce these provisions and grow their books further in a renewing real estate market.

The result is that over the next few years, the unwinding of this over-provisioning will see a rerating of earnings, ahead of the consensus expectation at the time we began up-weighting into banks.

Resources

Metals and mining are in the midst of two fundamental themes in global resources investing. The first is the super-cycle demand for Australia’s bulk commodities, including iron ore, from China in terms of building and infrastructure demand, and as a function of the growth path of the world economy. This theme is expected to drive earnings in companies such as BHP, Rio Tinto, and Fortescue Metals.

The second is the fundamental shift in the energy transition to renewable energy, and the rapid adoption of electric vehicles, which is sparking a secular demand for bulk, base, and battery materials (copper,  lithium, cobalt, zinc, manganese, and rare earths) that is expected to last for decades, underwriting the fundamentals of a strong resources market.

This long secular “electrification” demand is forecast to drive earnings in companies such as Galaxy Resources (ASX: GXY), Orocobre (ASX: ORE) and IGO in lithium (ASX: IGO), OZ Minerals in copper (ASX: OZL), and Lynas Rare Earths (ASX: LYC).

Ausbil has been overweight banks and resources (metals and mining) for some time. These overweights remain in place across our portfolios and have driven outperformance across our different strategies.

Importantly, we are still in the early stages of the economic cycle, with a positive growth outlook for multiple years that is expected to drive performance in these mega-sectors.

The portfolio is also tilted towards rebound stocks in travel and recreation, such as Qantas Airways (ASX: QAN) and Webjet (ASX: WEB), the earnings of which are returning following the implementation of global vaccinations, as well as high-quality industrials and healthcare names, such as Ramsay Health Care (ASX: RHC), that are primary beneficiaries of economic recovery.

Where next?

Since the historic reversal in consensus across the February reporting season that saw the FY21 consensus earnings outlook for the broad market rebound from -1.6% to +15.6%, consensus earnings outlook for both indices has rerated to +19.08% (S&P/ASX 200) and +19.02% (S&P/ASX 300).

While these earnings figures are strong, Ausbil’s view is that consensus is still underestimating the rebound in earnings that will occur in the prevailing economic conditions, with rates to remain low, and with the world economy providing a tailwind to Australia’s current expansion.

In terms of the market itself, three important observations can be made when looking  at the earnings growth and levels:

1. The consensus earnings outlook regularly misses the actual earnings by some margin (as shown in the red and blue bars) in the chart below.

Moreover, in the expansion phase of 2004-2007, consensus significantly and consistently undershot actual EPS growth. What is interesting about this period is that it shows the multi-year expansion of year-on-year positive earnings-per-share (EPS) growth that could be similar to the period of earnings expansion we have just entered in 2021.

2. Since the GFC, aggregate earnings have moved sideways, within a range.

Market performance has been driven by significant Price/Earnings (PE) expansion in this time rather than earnings expansion. Ausbil’s outlook is for the return of strong multi-year earnings over the next 2-3  years, and possibly beyond.

3. Markets are volatile and can rise and fall on anticipated and unanticipated information.

However, comparing the market and EPS levels over time shows that markets tend to rise when earnings are in a rising pattern, or conversely, the market is unlikely to fall significantly when it is in an earnings upgrade cycle.

Ausbil’s portfolios have been positioned for a clear path to recovery, but with some volatility and uncertainty along the way. We are expecting a multi-year earnings growth cycle, and we maintain the position that investors are compelled to participate.

While we maintain a positive outlook on earnings, this is still a time to invest in only the best-quality companies that exhibit superior underlying earnings growth and strength, to achieve longer-term outperformance.
 

Australia’s recovery growth path

Source: FactSet, Ausbil, 2021