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After reporting "abnormally high" earnings during the COVID-19 pandemic, Australia's 200 largest companies are now expected to announce falling profits for a second straight year.
That's the prediction of global investment bank UBS, which believes "this 'sugar rush' period has now passed".
The bank's investment strategist, Richard Schellbach, is predicting earnings from ASX-listed companies, on average, will have fallen 3.5 per cent in the past financial year (2023-24) — following a 2.9 per cent drop in the previous year.
"The year-on-year numbers for a lot of companies are still going to be a negative story for earnings growth," Mr Schellbach told The Business.
"Whether it's the energy companies, miners, consumer staples, and banks, they're coming off what were record and unsustainably high profit levels a year or two ago."
Back then, interest rates weren't as high — and many people had savings, which hadn't depleted as much as they have now.
During the next few weeks, hundreds of Australian companies will be reporting their full-year or half-year earnings, and how much of a dividend they'll be paying shareholders.
And expectations will be sky-high, given the share market is still trading near record levels, despite suffering its worst meltdown since COVID first struck.
Investors will be deciding whether these companies' profits (and their CEOs' estimates of future earnings) are good enough to justify the price of their shares.
Essentially, reporting season is a chance for shareholders to find out if they're paying too much. If so, these companies with underwhelming results tend to be punished with big falls in their share price (and conversely, big gains if their earnings beat expectations).
So it could potentially be quite a volatile time for many companies in the weeks ahead.
Banks, miners under pressure
One of the most closely-watched companies will be Commonwealth Bank — which is trading near a record high and will announce its full-year profit on August 14.
The nation's largest bank announced an eye-watering $10 billion profit last year, and recently overtook mining giant BHP to become Australia's most valuable company.
Commonwealth Bank's market value is around $213 billion, which is slightly higher than BHP's valuation of $208 billion.
Many professional traders believe CBA is overvalued (when comparing its earnings and share price).
In fact, most analysts have attached a "sell" recommendation for CBA shares, according to data from Refinitiv.
"Its earnings have been flat … yet its share price has been surging," said Jamie Hannah, deputy head of investments at VanEck.
"It's certainly just a strong momentum play that people are buying things as it's going up. That said, I don't believe its fundamental valuations is essentially backing up that price."
Miners will also be under the spotlight, as investors assess how much their profits have dropped as a result of China's sluggish economic performance (and slowing demand for Australian commodities like iron ore).
"What we've seen emerge over the last three to six months in China are the baby steps towards a debt deflation spiral," Mr Schellbach said.
"This is the scenario which has long been a fear over the Australian economy and equity market. And it explains why some companies like BHP are seeing their share price down [around] 20 per cent year to date."
Insurance the likely stand-out
On the flip side, insurance companies are likely to be the "star performers off the back of their pricing power", according to Mr Schellbach.
"What we've sort of noticed over the last decade is insurance products move from being perceived as a consumer discretionary type item to a consumer staple item."
That is a view shared by many investment analysts.
"It's offering really strong growth at reasonable valuations and that is quite hard to come by," said Anna Milne, senior investment analyst from Wilson Asset Management.
"Within that, there are a few different names that we like [including] Insurance Australia Group (IAG), Medibank and Austbrokers (AUB Group), and they all are quite defensive. We think their earnings story is under-appreciated and they're not so well-owned at the moment."
This year, several health insurance providers have significantly lifted their premiums — by as much as five times the annual average increase approved by the government.
How will spending impact consumer sector?
The upcoming results of JB Hi-Fi, Lovisa, Flight Centre, Myer, Premier Investments and other consumer discretionary stocks will also come under heavy scrutiny.
Mr Hannah believes the discretionary sector will hold up better than expected.
"Unemployment is still low in Australia, and we still have high immigration," he said.
"Australians are still buying technology, they're still upgrading their phones [and] they're still buying televisions or computers when they need to.
"And there have been a lot of discounts at the retailers recently, which is certainly helping to grow sales within some of these companies."
Indeed, many retailers have been holding "clearance" and "sale" events (with sizeable discounts) that never seem to end.
Mr Hannah said this extended period of discounts may hurt some of these companies' profitability.
Ms Milne, however, is not feeling optimistic about the strength of consumers in the months ahead.
"We still don't think we're out of the woods," she said.
"We now have some fiscal stimulus by way of tax cuts, that will certainly help the households. But we are working through the savings buffer.
"I think we're almost empty when it comes to the savings buffer across certain demographics, and so that has to come to the fore [with corporate] earnings at some point.
"We don't see a lot of earnings growth for these companies into the next year, nor do we see valuation upside."
Volatility and 'mediocre' growth ahead
Despite the short-term risks, some analysts are feeling more upbeat about next year's reporting season (2024-25).
"What we've never seen is three consecutive years of earnings contractions, and that gives us some comfort," Mr Schellbach said.
"And that gives us comfort that earnings growth is set to resume as we head into FY25."
On the other hand, Ms Milne is not expecting share markets to rise significantly in the year ahead.
"When we look at earnings growth, it's looking relatively mediocre at best," she said.
"It might be 3-4 per cent in a bullish scenario, and valuations are high. In our view, it's hard to make an argument stack suggesting that market indexes overall will be much higher over the next six to 12 months."
The US presidential election, meanwhile, is expected to be a significant driver of market volatility towards the end of the year — on Wall Street, ASX and worldwide.
"If they looked more likely that the Republicans are going to get into power, energy [oil and gas] companies would do considerably better," Mr Hannah said.
"If it looks like the Democrats were getting in, you'd see some of those energy companies probably do worse, while the greener companies in relation to energy transition would do better."