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Brace for a wave of downgrades as UBS picks the ASX stocks most at risk

Our bull market is on life support! The biggest near-term risk that could tip it over the edge may be the wave of earnings downgrades that’s about to hit the S&P/ASX 200 Index (Index:^AXJO)

The top 200 stock benchmark may have closed in positive territory on Friday but the index is now only 15.3% above the bear market low of March 23.

It’s given ground after jumping more than 20% from that trough. A bull market is defined as a jump of 20% or more from the bottom.

Earnings expectations set too high

Investors are understandably nervous. It’s an open secret that consensus earnings forecasts will need to be pared more due to the COVID-19-triggered economic recession.

So far, analysts haven’t collectively downgraded earnings by nearly enough, warned the head of Australian equities at T. Rowe Price, Randal Jenneke.

“Containment measures are resulting in a sudden loss of revenue for Australian companies and downgrades are inevitable,” said Jenneke.

“However, if history is any guide, the current -9% consensus downgrades since the peak are grossly understating the pain.”

The fund manager noted that the average downgrade from past recessions stand at around 30%.

Dividend downgrades worse than earnings

But T. Rowe Price isn’t the only one to point out that the ASX is in a cum-downgrade cycle. UBS is moving ahead of the pack to downgrade their earnings expectations for 2020.

“Consensus EPS [earnings per share] revisions are now falling at the fastest pace since the GFC, while revisions to DPS [dividends per share] are now falling at nearly twice the pace of falls seen in the GFC,” said the broker.

But UBS doesn’t think consensus estimates are falling fast enough. Its analysts have cut their calendar 2020 EPS forecast by 23% (or 22% for FY20) since February.

Dividends have been trimmed even more aggressively. UBS lowered its DPS estimates by 30% for CY2020 or 34% for FY20.

The broker warned that the market’s EPS and DPS won’t recover to FY19 levels until FY23.

ASX large caps most at risk

What’s perhaps more alarming is that there are a number of popular stocks on the S&P/ASX 100 (Index:^ATOI) (ASX:XTO) that are at risk of consensus downgrades.

The stocks where UBS is at least 10% below consensus earnings estimates include buy now, pay later market darling Afterpay Ltd (ASX: APT) and big banks Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd. (ASX: NAB) and Westpac Banking Corp (ASX: WBC).

Two of our listed regional banks are also on the list. These are Bendigo and Adelaide Bank Ltd (ASX: BEN) and Bank of Queensland Limited (ASX: BOQ).

Other stocks in this at-risk group are SEEK Limited (ASX: SEK), Alumina Limited (ASX: AWC), Iluka Resources Limited (ASX: ILU), NIB Holdings Limited (ASX: NHF), Carsales.Com Ltd (ASX: CAR), Challenger Ltd (ASX: CGF), Medibank Private Ltd (ASX: MPL), Cochlear Limited (ASX: COH) and Sonic Healthcare Limited (ASX: SHL).

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Brendon Lau owns shares of Commonwealth Bank of Australia, Iluka Resources Ltd., National Australia Bank Limited, and Westpac Banking. Connect with him on Twitter @brenlau.

The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of Cochlear Ltd. The Motley Fool Australia owns shares of and has recommended Challenger Limited. The Motley Fool Australia owns shares of AFTERPAY T FPO. The Motley Fool Australia has recommended carsales.com Limited, Cochlear Ltd., NIB Holdings Limited, SEEK Limited, and Sonic Healthcare Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.