One aspect of the big miners’ reports that will be intriguing to us is how their capital expenditure expectations have changed over the last six months. With the rally in commodity prices, we have seen mining service companies follow suit. In recent years, these services companies have seen their order books shrink as mining work has been cut back. The expectation now is that with the higher commodity prices, capital expenditure budgets will increase and work will start to flow back to the contractors. This work won’t come from expansion of production but more likely through maintenance work that has been delayed in recent times in the name of boosting cashflow. The degree to which the likes BHP and RIO increase their capital expenditure budget for the coming years will help tell us to what degree the recent rally in mining services stocks is justified.

Overall, the direction of the market over the early part of this year will most likely come down to the largest sector, Financials. Within financials, the key driver will be the banks. We have Commonwealth Bank set to report its half year result as well as quarterly updates from the other 3 of the big 4 and the consensus expectations for the sector this year are reasonably low at 2% growth. However given the recent rally in the share prices of the banks (the big 4 are up between 11 and 18% since the US election); we’d suggest that the market is running ahead of the sellside analysts in upgrading future earnings. We are sceptical that these upgrades will occur and we wrote in depth about the challenges facing the banks from the Western Australian and Queensland economies last week (see 2017 Outlook).  Typically problems in the housing market take a while to play out however the increase in arrears from WA over the last 12 months suggests we may start to see an impact on the profit numbers soon. With only CBA set to give a detailed half year report in February, we may have to wait until the other three release their results in May to get a full view of how this is playing out.

The other areas within the top 20 companies which are seeing earnings pressures are Consumer Non-Cyclicals and Telcos. The consumer side is dominated by the two large supermarket chains, Woolworths and Coles (owned by Wesfarmers). The supermarkets are facing increased competition from Aldi and Costco combined with the potential entry of Lidl. There seems to be no respite from these pressures in the near term, however Wesfarmers should see a boost to their result from Coal prices over the last six months.  The Telco sectors is dominated Telstra, where earnings would be going backwards if not for the reimbursement from the government for the NBN. Telstra, by their own admission, have a $2-3bn earnings hole to fill over the coming year. So whilst investors may still be attracted by the significant yield on their shares, the uncertainty of their longer term earnings plus the increased competition in the sector makes us cautious on the outlook.

When we look at the earnings expectations above, it’s no surprise that the materials sector was far and away the best performer last calendar year with a very strong rally off a low base.