Political and regulatory risk mean investors should brace for a tougher second-half to fiscal 2019, even as results for first half earnings season so far have been largely positive and met expectations.

Australian businesses that operate primarily within this country face considerable uncertainty
with the looming federal election, cooling house prices, and low wage growth – all of which feed into negative consumer sentiment and low household wealth.

"The consumer is feeling frugal," says Jun Bei Liu, a portfolio manager from Tribeca Investment Partners, speaking just as first-half earnings season reached its mid-point in February.

Domestically, the tone has been similar to that of the US, where 2018 fourth-quarter earnings have, on aggregate, been upgraded by 3.7 per cent.

“However, looking ahead, first-quarter US corporate earnings growth is looking a little bit weaker. So far, we have seen earnings growth forecasts for [this period] downgraded by 4 per cent,” says Liu.

Trouble on the horizon in Australia, US

Liu also points to a more negative outlook for the second-half 2019 by the management of ASX 200 companies, who have in many cases trimmed their guidance for the full-year.

She thinks it unlikely the Australian share market will outperform either the US market or emerging markets this year, given stronger earnings growth and cheaper valuations in North America and major emerging market economies.

Liu forecasts earnings growth of 4.2 per cent for the ASX 200 for the 2019 calendar year, which compares to around 6 per cent for the S&P 500 in the US, and 7.5 per cent for Asia ex Japan.

This follows earnings growth of just over 7 per cent in 2018 for Australia. An improvement in the nation’s terms of trade, spurred on by higher commodity prices, won’t be enough to offset lower earnings growth this year, with the big banks’ low earnings growth weighing heavily on the ASX 200, says Liu.

By contrast, the blended earnings growth rate for the S&P 500 is 13.3 per cent for the final quarter of 2018, according to data from FactSet. If this is realised, it would mark the fifth straight quarter of double-digit earnings growth for the index, highlighting the strength in that market.

However, looking ahead to the first quarter of 2019, negative earnings guidance among S&P 500 companies outstrips positive forecasts by a ratio of more than four to one.

Risk

Around 4-to-1 listed US companies are negative versus positive in their 2019 outlook

 

More than 50 companies within the major US index have issued negative EPS guidance, while just 12 are looking for positive growth as at 8 February 2019, according to data from FactSet.

Other wealth managers are more upbeat on international equity markets. Crestone Wealth Management has recently shifted to an overweight position on international equities versus domestic stocks.

“This reflects a combination of Australia’s recent relative outperformance, a less compelling earnings outlook and heightened concern about a housing correction that may add further downwards pressure to the Australian dollar.

The rising political risk ahead of an expected federal election in May this year is also a key factor,” says chief investment officer Scott Haslem.

In September, Crestone increased its allocation to emerging markets, with a focus on Asia ex-Japan.

“Emerging markets have outperformed in Australian dollar terms since then. With valuations still attractive, and some potential for stabilisation of the economic and geopolitical backdrop, we have increased our overweight in emerging market equities this month.

"With improved prospects for avoiding a no-deal Brexit, and now supportive valuations, we have also closed our UK underweight," Haslem says.

The manager has also shifted away from its prior overweight allocation to European stocks, on the back of weak European Union data, and remains neutral on US equities.

"A reversal of fortunes for emerging markets would benefit both Europe and the UK,” says Haslem.

Local healthcare, tech attractive: Bennelong

But some managers still see value within Australian equities.

Julian Beaumont, investment director at BAEP, still likes the domestic healthcare and technology sectors.

“Healthcare is mostly immune to a slowdown, and is growing on account of a number of factors such as the ageing population and innovation," he says."

Beaumont cites Global biopharmaceutical CSL (ASX: CSL) as one good example, largely due to its ongoing growth in patient numbers strong pipeline of new products.

“One less appreciated area of resilience is in technology, where in some pockets the growth is underpinned by their disruption into already large markets.

Software-as-a-service businesses such as Xero (ASX: XRO) and Workday can actually benefit from a slowdown, as their potential clients take up their products in an effort to save costs in more difficult times,” he says.

Beaumont downplays the effect Australia's federal election is likely to have on corporate earnings.

“Uncertainty leading into the federal election will likely affect consumer and business confidence, but as something that happens every four years or so, it’s nothing to be concerned about," he says.

That said, Beaumont says the most elevated risks are in those sectors most reliant on government funding and policy – including aged care, healthcare service providers, energy retailing, childcare, and, of course, the banks.