Don’t count your chickens on a sustained recovery just yet: UBS expects corporate earnings to fall 20%

The prospect of downward revisions to earnings estimates adds to the angst currently facing investors over inflation and the impact of further Reserve Bank tightening. 

At least that’s the clarion call from UBS, with the broker warning Australian investors to factor in the real prospect of a 20% fall in corporate profits over the next six months.

While adamant the Australian economy can avoid a recession, UBS warns of economic slowdown triggering a period of earnings downgrades which could extend into early 2023.

S&P/ASX 200 forecast to drop 6%

In light of these downgrades UBS has also trimmed its S&P/ASX 200 year-end target from 7700 to 7000 - currently 6716 - which at face value implies a 6% fall for the calendar year.

Underscoring this outlook is the ASX’s heavy weighting towards materials and financials stocks.

While these two sectors have historically incubated the local market from previous global sell-offs, they have struggled over the past year, and more acutely over the past month, due largely to concerns over interest rates and slowing growth.

Inflection point

The broker regards the discrepancy recently witnessed between prices and earnings estimates as a strong flag to investors of a pending inflection point for equity markets.

UBS concludes that with earnings now destined to mirror a fall in equity prices, cuts to earnings estimates will be experienced well into 2023.

Courtesy of the recent sell-off across global equities, the Australian share market, is down around -10% year to date, and -7.2% since the start of June.

Sustained recovery some time off

Despite last week’s relief rally, which saw some rotation from energy and materials into financials and technology stocks, the broker believes it’s too early for investors to kick against any impending earnings downgrades cycle.

Despite a lot more conviction around institutional order flows last week - especially in unloved stocks where the market identified rich veins of value - the broker reminded investors that during past ASX earnings downturns, share prices haven't experienced sustained recoveries until they were at least halfway through the cycle.

“The shortest of these prior profit cycles was eight months in duration, which, if mapped to now, would suggest that equity prices will remain hostage to negative earnings momentum until the fourth quarter of this year,” noted UBS strategist Richard Schellbach.

Sectors at risk

Despite overarching caution heading into the upcoming reporting season, UBS remains Overweight on resources stocks, one of the worst performing sectors in June down -8.2%.

The broker has also upgraded consumer staples to Overweight from Underweight due to the visibility of their dependable earnings.

The broker expects the consumer discretionary sector (down -6.69% in June) and then banks (which tanked -13.38% in June) to be early flagbearers of a more broad-sweeping earnings downgrade cycle, and recently downgraded the former to Underweight from Overweight.

“Although the share prices of banks may have already adjusted to the tougher macro-outlook, a series of profit downgrades over coming months dictates that share prices will remain constrained,” Schellbach noted.

ASX 200 chart over 12 months.