1) It has been a brutal year for those of us invested in growth and/or small cap stocks, with sharply rising interest rates having the effect of sending share prices of many such companies down 50% or more.
And the fight against inflation is not over yet, with central banks around the world still tightening, hoping to pull off a miracle soft landing, but more likely sending many economies into recession.
The narrative is shifting from questioning how high interest rates need to rise, and when central banks will pivot to lowering them, to predicting the severity and duration of the economic downturn.
"Wall Street's 2023 profit decline could rival GFC," says the headline in the AFR, with Michael Wilson, Morgan Stanley's chief US equity strategist, saying the earnings recession could be similar to what transpired in 2008-09.
Based on its bearish earnings forecast, the investment bank is suggesting US equities could plunge more than 20% from current levels. Thankfully, "Morgan Stanley does not see signs of distress in the housing market or systemic financial risk, meaning it does not expect 50 per cent downside for shares, as seen in 2008," according to the AFR article.
"The fixation on inflation and the Fed continues, but markets appear to have moved past it and onto the real concern – earnings growth/recession," Mr Wilson said. "Rates and inflation may have peaked, but we see that as a warning sign for profitability."
2) Right on cue, enter plus size retailer, City Chic Collective Ltd (ASX: CCX) which today warned of continued volatile trading, with overall demand below expectations.
In response, City Chic has increased its promotional activity to drive demand, resulting in further gross margin compression. The company now expects to report a small underlying EBITDA loss in the first half, a half that encompasses the peak Black Friday and Christmas trading periods. Or should that be Red Friday, given Black Friday is thought to derive its name from the day when retailers go from losses to profits in the trading year?
The City Chic share price has taken yet another bath today, down 22% to 46 cents, and is now down 91% in the past 12 months.
Buying a falling knife – like City Chic – is fraught with danger. Profit warnings often come in threes, and turnarounds either don't turnaround, or can take longer than expected to recover.
It appears the Spheria Asset Management Australian Microcap Fund has been on the wrong side of the City Chic trade – so far at least – given comments in its November monthly update…
"We believe the share price fall has created an opportunity to buy a business at a significant discount to our view of its intrinsic value. The core driver of their earnings continues to be their Australian City Chic store business. Given the share price weakness you are buying the Australian business for ~5x normalised EBIT with potentially more upside for profit turnarounds at its international online businesses – Avenue (US based) and Evans (UK based)."
Stock picking – especially in this economic environment – is tough, especially in the retail sector. Consumers' willingness to spend on discretionary items is clearly going to deteriorate in 2023 as higher interest rates eventually take their toll.
Beware the falling knife.
3) Coal, lithium and energy stocks have helped the S&P/ASX 200 Index (ASX: XJO) avoid the big falls seen on US markets, the Whitehaven Coal Ltd (ASX: WHC) share price taking the gold medal for the biggest gain in 2022, up over 300%, showing coal demand to be anything but in terminal decline.
Also helping prop up the ASX 200 index have been three out of the four big bank shares, with Westpac Banking Corp (ASX: WBC) shares up 8.9%, National Australia Bank (ASX: NAB) shares up 4.9% and Commonwealth Bank of Australia (ASX: CBA) shares up 4.6%. The odd bank out is Australia and New Zealand Banking Group Ltd (ASX: ANZ) shares down 13.8% so far in 2022.
Beloved for their full franked dividends, bank shares also prop up many self managed super funds, helping deliver a solid year for many retirees.
As thoughts turn to 2023, a year of falling house prices and subdued consumer confidence – and with them, lower lending demand and higher default rates – the premium valuation afforded CBA shares leaves little downside protection.
Even the famed CBA fully franked dividend is not looking overly attractive, yielding just 3.6%, about the same as you can earn risk-free in a bank savings account.
CBA shares are not the only popular blue chip stock trading on a premium valuation. According to S&P Capital IQ, Telstra Group Ltd (ASX: TLS) shares trade on 28 times earnings and Woolworths Group Ltd (ASX: WOW) shares trade on 27 times earnings.
Put another way, that's an earnings yield for both stocks of about 3.5%, a rating that might make sense when interest rates are at close to zero, but leaves little downside protection with the RBA cash rate likely headed to 3.6% before Easter.
Retirees looking to preserve capital whilst banking fully franked dividends from popular blue chip stocks might be looking at a much tougher 2023.
