UBS Warns That It’s Premature to Invest in the ASX 200 Dip

Australian Equities Face a Challenging Week: UBS Analysis

The Australian equities market, represented by the S&P/ASX 200, has experienced a significant downturn, marking a seven-day losing streak with a decline of 3.0%. Consequently, the index is now marginally down for the year. While this slump may attract bargain hunters, analysts at UBS caution that investors may be premature in overlooking macroeconomic, inflationary, and earnings risks.

Economic Projections Adjusted

UBS has revised its forecasts for GDP downwards while simultaneously increasing inflation expectations since the onset of the Middle East conflict in late February. This combination could lead to stagflation, adversely impacting earnings projections. Notably, estimates for ASX 200’s 12-month forward earnings have shifted from a predominately positive outlook to a negative one, with energy being the only sector showing meaningful upgrades.

The UBS team posits that the interplay of subdued GDP growth, elevated oil prices, and persistent inflation is likely to result in widespread earnings downgrades in the near future.

Potential Shift from Upgrades to Downgrades in Earnings

Historically, rising oil prices and declining Purchasing Managers’ Index (PMI) figures have prompted downward revisions in ASX 200 earnings. Currently, UBS observes these conditions prevailing.

Past Downgrade Cycles Analysis:

• Global Financial Crisis (2008-09): Earnings downgrades spanned approximately 18 months, with earnings-per-share (EPS) decreasing by 17% to 63% and share prices plummeting by 28% to 78%.
• COVID-19 Period (early 2020): This cycle, however, lasted only 5 to 9 months, with EPS falling between 20% and 54%, and prices dropping 25% to 49%.

Historically, share prices typically reach their lowest point around halfway through an earnings downgrade cycle, suggesting that stock markets can bottom out two to three quarters ahead of economic turnarounds.

‘No News is Bad News’ Screening

UBS conducted a screening for stocks that have seen a price drop of over 10% since the onset of the conflict, while earnings expectations remained largely unchanged.

Identified Stocks Include:

• Temple & Webster
• ARB Corp
• Fletcher Building
• Super Retail
• Harvey Norman
• Nick Scali
• Amcor
• Stockland
• Flight Centre
• PEXA
• Ansell
• ALS
• Mirvac
• Orica
• SGH
• Brambles
• Reece
• Downer
• Auckland International Airport
• Seek
• Domino’s
• Endeavour
• Ingenia
• Monadelphous
• Light & Wonder

Whether this screening presents an opportunity or a warning depends on individual investor outlooks, yet UBS adopts a more cautious stance.

Impact of Recent Announcements

An analysis of 21 announcements referring to the conflict between March 10 and April 24 revealed that stocks had generally fallen by an average of 8% before updates, followed by an additional 4% decline on announcement days.

Sample of Updates:

• Air NZ (10-Mar): Suspended guidance; shares decreased by 1.1%.
• Orica (10-Mar): No immediate impacts noted; shares decreased by 3.4%.
• Fletcher Building (16-Apr): Middle East impact not ascertainable; shares dropped by 2.4%.
• Cochlear (22-Apr): FY guidance downgraded; shares plummeted by 40.7%.
• Judo Capital (24-Apr): Confirmed guidance at low end; shares increased by 1.4%.

UBS’s equity strategist Richard Schellbach noted that "not all the bad news was in the price," suggesting that it’s too soon to buy into the earnings weakness.

Valuations Lack Margin for Error

The ASX 200 is currently trading at approximately 19 times FY26 earnings estimates, with estimated EPS growth of 12.8%, driven predominantly by the resource sector. However, sector valuations vary significantly:

• Energy: 19.1 times FY26 EPS, with expected earnings decline of 15%
• Materials: 16.4 times, projecting 32% EPS growth in FY26
• Health Care: 18.4 times after a 20% decline in three months
• Technology: 79.2 times, the highest sector valuation
• Discretionary: 23 times, experiencing a 13% drop over three months

Conclusion

UBS’s cautious view rests on three primary considerations:

1. The earnings cycle has peaked and is beginning to trend downwards.
2. Historical patterns indicate that share prices usually bottom out before the earnings.
3. Recent announcements suggest that the market is still adjusting risk valuations rather than having priced them in completely.

While not every declining stock presents a value trap, the prevailing macroeconomic signals indicate a downward trajectory for earnings.