During February most ASX listed companies reported financial results to the end of December 2022, with reported numbers, overall, slightly underperforming expectations. Company guidance for future earnings was also below expectations, with about 60% of companies downgrading guidance by an average of ~1.5%.
The impacts of COVID-19 are now winding down and the market anticipates a more normalised environment, without the support of cash handouts and emergency interest rate settings. Key macro factors in focus include GDP numbers as well as inflation (CPI), given the impact these have on interest rates.
Regarding inflation, supply-side factors (eg: energy and freight costs) have fallen significantly, whilst others have risen (eg: wage costs). Quality businesses have demonstrated an ability to pass through cost inflation to customers and maintain profit margins, thus evidencing pricing power.
Weaker household demand because of increasing interest rates, is anticipated to impact company revenues. A combination of increasing mortgage serviceability costs and the negative wealth effect (people spending more when they think the increasing value of their home will pay for it) should make increasing company revenue difficult.
Whilst all the above issues sound negative, these and many other factors are well known and (supposedly) priced into share prices. As we have seen during the past few years, theory can be far removed from reality and events move very quickly. A change in pace of inflation may result in different interest rates settings. These changes are difficult to forecast, especially by those in charge of setting policy, our Central Bankers. A diversified portfolio of defensive businesses with a track record of resilience through an investment cycle has proven historically to be an astute strategy. We don’t think it is different this time.