Australia's profit recession over, earnings expected to rise

Australia's profits recession is at an end, and earnings should turn positive into next year, levelling the playing field for unloved value stocks which have been long eschewed in favour of growth stocks, Fairfax Media reported on Monday.

"The defining feature of the Aussie equity market over the last two years has been the profits recession," Credit Suisse equity strategist Hasan Tevfik said, the fifth of its kind since 1980.

Much of the 13 percent fall in earnings per share during the recession was due to resources stocks weathering the worst of the mining downturn and the nadir of commodity prices in January.

With commodity prices stabilising and these now leaner companies returning to profit, Credit Suisse is forecasting single digit EPS growth over the next year, which should send the S&P/ASX 200 Index back to 6000 points by December next year.

This may also give rise to a shift in the market which has been marked by the valuations of high growth stocks being pushed to extremes as investors search for yield and growth amid an uncertain macro backdrop.

"We think we are at an inflection point in the profits cycle," Tevfik said in a quarterly outlook piece.

Not only are earnings likely to rise off the back of higher commodity prices, but the outlook for economic growth is also improving for next year, Perpetual's multi-asset head of investment strategy Matthew Sherwood said.

"In the next year the Australian economy is clearly going to strengthen because one of the big headwinds in the last few years is the mining investment unwind, and I think by this time next year that will largely have dissipated," Sherwood said.

"I tend to think that GDP growth is going to be better in a year's time, it's already pretty robust," he said.

Tevfik said while the investment bank had upgraded its global growth forecast from 2.6 percent in 2017 to 2.8 percent, the growth was low relative to other turns in the profit recession cycle.

"For these reasons we think the coming EPS recovery will be modest and expecting mid-digit growth for the ASX 200 during the 12 months to June 2017," he said.

While the outlook for earnings is positive, Sherwood said it would not be all smooth sailing, with financials coming under pressure as it passes the bottom of the bad and doubtful debt cycle and a squeeze in their margins.

"The key for which sectors outperform, growth versus value and defensive versus cyclical, is the performance of long dated bond rates," Sherwood said.

If bond yields continue their march higher, value and cyclical stocks would outperform, but this would be more likely driven by global factors, particularly the global real interest rate, than local drivers.

Australia's ten year bond yield has risen from 1.819 percent in August to 2.303 percent.

"I'm of the view that we've seen the most of the bond yield rise to date. I don't expect there's going to be a further leg up," he said.

Tevfik said the end of the profit cycle will even the playing field for stocks, and rising EPS and bond yields would help reduce the premium associated with growth stocks. Enditem