A positive pointer to 2013 profits

January traditionally is confession time for Australian corporations.

With the half-year books signed off on December 31, and with a couple of weeks to go before reporting season begins, this usually is the time earnings revisions are announced.

Last year was a shocker. The anticipation of a strong earnings recovery failed to materialise, and from early 2012 the earnings downgrades just kept on rolling.

Consensus estimates this time last year had Australian corporate earnings rising by 20%. That was duly reduced to 14% during the full-year reporting season and since has been slashed to zero.

Despite earnings heading into reverse during the second-half of 2012, the stockmarket rallied, and rallied hard. Stock prices rose as earnings went into reverse. And it is that factor that has battle scarred analysts worried right now and full of pessimism. Concerned that stock prices have run well ahead of earnings, no-one wants to be caught out again.

But as each day passes, the indications are that we have reached the bottom of the earnings trough. So far, apart from notable exceptions like Billabong, there has been little in the way of downgrades. BlueScope this week announced further rationalisation and job cuts. Boral announced massive layoffs and cost restructurings. But no mention of earnings concerns.

Earnings near trough

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Source: RBS Morgans

Like many industrials, both companies have suffered extensive damage to their businesses, battered by a combination of sluggish construction growth and a stubbornly high Australian dollar. Those factors are continuing to weigh upon them. But they are adapting to that environment through cost reductions, asset sales and internal reorganisations.

While early indications are that the worst has passed, there is no guarantee that this year will signal a dramatic turnaround in the fortunes of our industrial and service sectors. It is more likely to be a year of consolidation and steady gains.

It is also worth noting the share price performance of Boral on the day of the announcement. It was the best-performing stock on the ASX with a 10.4% rise, indicating perhaps the level of short selling activity that has focussed on cyclical sectors such as building materials and media. When the news isn’t bad, stocks respond in an extremely positive manner.

Whether the Australian market is overvalued is a moot point. Trading at a price earnings multiple of 13.4, slightly below the long-term average, many investment banks and analysts argue it is. There is no doubt defensive sectors certainly are above their long run average following the strong performance in the second half of 2012.

Much of that rally was driven by yield as domestic rates were cut. There are fears the yield push has run out of puff, that it will not drive demand for equities this year.

But it is worth noting the average yield on the ASX 200 is 4.5%, which is still attractive globally and sits at a reasonable premium to the 10-year government bond. On top of that, the pressure on rates will continue to be downward, making equities more attractive.

Dividend yields attractive

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Sources: Global Financial Data, Datastream, Bloomberg, IBES, CIMB

With the Reserve Bank acutely aware that the economy is in a transition phase as investment slows in the resources sector, the chances of further interest rate cuts this year are high, particularly after the employment numbers on Thursday showed a rise in unemployment to 5.4% and a continuing trend towards part time employment.

Globally, there is no immediate sign of any let-up in the aggressive monetary easing policies in the US, Europe and now Japan. All that extra liquidity will need to find a home. And with both the US and China now showing real signs of growth, investors will be looking for Australian corporate earnings growth in the 2014 financial year.

Right now the only obstacle standing in the market’s way is the immovable Australian dollar (see John Abernethy's The high dollar trap). As America recovers, the greenback will start to climb. If that coincides with a drop in Australian resource investment in 2014, the currency shift could be dramatic. And the earnings jump will reflect that.

For the next fortnight, however, keep an eye on the confessional queue. If the numbers remain as thin as they have, it is a good sign the earnings slump is over.