WEEKEND ECONOMIST: Earnings optimism

Better-than-expected earnings results continue to roll in from the US and Europe. Meanwhile, Australia's latest inflation figures signal that the RBA will keep rates steady.

The past week has seen more better-than-expected data out of Europe, but mixed data out of the US. While US earnings results have softened a bit in the last week, they have still been strong, with 75 per cent of the companies to have reported so far exceeding expectations. And while cost control has played a big role, 67 per cent of companies have so far surprised on the upside in terms of revenue growth.

In Europe, 60 per cent of companies to report so far have exceeded earnings expectations and 69 per cent have exceeded revenue expectations. This is providing solid support for equities and also provides a positive omen for the Australian profit reporting season over the next month.

In Australia, the big news was far weaker-than-expected inflation in the June quarter. On top of this, soft data for private credit growth in June and a 0.7 per cent fall in capital city house prices, according to RP Data-Rismark, reinforce the case for Australian interest rates to remain on hold. It is now quite clear that six interest rate hikes and a sharp fall in affordability have brought to an end the recent surge in house prices – housing finance, auction clearance rates and now house prices have all clearly softened. By the same token, we don’t see this as the start of a collapse in house prices as the shortage of housing will put a floor under prices. Rather, we see subdued growth in average house prices over the year ahead.

Global shares were mixed over the last week, but commodity prices and the Australian dollar remained strong.

In the week ahead, the big focus will be the US ISM and jobs data and the Chinese manufacturing conditions index (or PMI). Regional surveys in the US suggest that the manufacturing ISM will likely fall to around 53 for July, from a reading of 56.2 in June. The lay-off of census workers is expected to result in a 70,000 fall in payroll employment in July, but the continued modest recovery in the economy points to a rise of around 100,000 for private payrolls.

In Australia, the RBA is almost certain to leave interest rates on hold, with the benign June quarter inflation reading giving it plenty of time to better assess the outlook for the global and Australian economies. We have pencilled in a September rate hike, but it’s quite conceivable that, with underlying inflation now better behaved and uncertainty continuing regarding the strength of the global recovery, the RBA will wait several months before feeling the need to raise interest rates again. The RBA’s Statement on Monetary Policy is likely to reinforce the impression that the bank still retains a tightening bias but there is no hurry to move again.

The Australian June half-profit reporting season will get under way in earnest, with stocks such as Crane Group, AXA, Alumina and Rio Tinto due to report. Key themes from the reporting season are expected to be: a return to profit growth with earnings per share likely to have risen 10 per cent in the 2009-10 financial year following a 20 per cent slump in 2008-09; a possible increase in dividends reflecting the improvement in cash flows, balance sheets and financing conditions; a negative impact on earnings for Europe-exposed companies from the strong rise in the Australian dollar versus the euro; and possible caution regarding the outlook for earnings in 2010-11. Resources, with likely 20 per cent profit growth, as well as banks, the media and retail sectors are expected to record the strongest profit growth.