The ASX's coal, oil and gas producers are on the cusp of reporting exceptional results in the annual profit season kicking off this week, drawing a line under a volatile year for the sharemarket as it faces a slowdown in growth.

Economists expect the Reserve Bank of Australia will upgrade its inflation forecast and increase Australia’s cash rate by another half a percentage point to 1.85 per cent from 1.35 per cent at Tuesday’s policy meeting.

While the battle to defeat high inflation with monetary tightening has posed a challenge for equities, it has not held back energy stocks.

The war in Ukraine and constrained supply from a cycle of under-investment spurred oil to a 14-year high in March, part of a broader rally that underwrote bull market prices for nickel, thermal coal and copper.

Commodities moderated last quarter, reflecting fresh downgrades to global demand and forcing forecasts for financial 2023 downward.

Still, the S&P/ASX 200 is set to bank earnings per share growth of 21 per cent for financial 2022, decelerating from the V-shaped windfall of 2021.

Resource sector earnings will swell by 33.7 per cent, according to Citi forecasts, which also tip market-wide dividends to grow by 5 per cent.

Big dividends and a return to growth is predicted for the banking sector, where Citi estimates earnings to rise by 9.1 per cent.

“Earnings have been strong – record in a lot of cases,” said Tribeca Global Natural Resources Fund portfolio manager Ben Cleary.

Whitehaven Coal stands to earn $3 billion when it reports full-year results on August 25; it achieved record average coal prices of $514 a tonne in the June quarter.

The bullishness of peak cycle prices and strong production across the board has lately been countered by fears of margin compression amid higher costs and coronavirus-related labour shortages, particularly in the Pilbara. But these concerns appear overblown, Mr Cleary said.

“Everyone had convinced themselves that there was going to be all these shocking reports on the back of rising costs and falling production,” he said.

“Yes, commodity prices fell in June, there’s been a bounce across most commodities in July, but the bigger thematic from this reporting season is there just hasn’t been any major production issues or major cost issues.”

A unique aspect of this profit season will be the oversized influence of BHP Group, which this year unified its dual-listed structure to a single primary listing and in doing so, boosted its index presence to around 12 from 7 per cent, according to Morgan Stanley.

Outside resources and banks, earnings are expected to grow by 8.6 per cent. And although technology stocks are in the grip of a bear market, their downturn in fortunes is barely perceptible from a profit perspective given the sector's record of losses.

Just seven stocks – the big four banks and big three miners – will contribute 60 per cent of total market dividends for 2021-22, Citi finds. Rio Tinto’s interim dividend of $US2.67 a share disappointed investors last week on the heels of last year’s enriched payout.

Investing conditions have shifted dramatically in the past six months as valuations adjusted on the apparent weakness in the outlook largely absent from financial 2022 accounts.

Rather, it is the outlook statements that will drive share prices as management incorporates the impact of rising input costs, rising wages, job market tightness, normalising household spending, and the rising cost of debt.

“Australia is a real dichotomy where the current market conditions are actually reasonable,” said Phillip Hudak, co-portfolio manager for Australian Small Companies at Maple-Brown Abbott.

“You look at the trading updates from the pointier ends of the market – consumer finance, the retailers – they’ve actually been reasonably good.

However, if you look at the forward indicators – business confidence, consumer sentiment – they’re rolling over, so it’s going to be a more challenging environment from here.”

Quality stocks face an even tougher test given they are investors' favourite place to hide, and command a historically high valuation premium.

“Quality companies is a very crowded trade.”

Morgan Stanley equity strategist Chris Nicol said buoyant business conditions have almost entirely reversed in the last six months, making outlook statements key amid contracting global growth and an aggressive interest rate tightening cycle. The US economy contracted for a second consecutive quarter in June, but it does not qualify as being in recession.

“If you think about what companies were talking about in February ... they were in a reasonably good position from investing in inventories, expecting a reopening economy and a consumer in pretty good shape, and they were expecting the RBA to be relatively dovish,” he said.

“We’ve seen almost every one of those things reverse. The RBA is now on our forecasts to raise the cash rate to 3.1 per cent by December. That’s effectively 300 basis points of cash rate increases in less than 12 months.

“The labour market has gotten tighter and we have supply shortages, so wage growth and costs are higher around the key components of running a business.”

Morgan Stanley estimates Australians boosted consumption of retail goods, excluding food, to a level that would normally have been met in 2037, based on pre-COVID-19 trends.

Profit warnings from US retailers such as Walmart last month signal a further deterioration in the US retail environment as consumers become more price sensitive. But that caution was largely missing from July's buoyant trading updates from JB Hi-Fi and Myer.

E-commerce retailer Kogan, beset by excessive inventory for the past 12 months, witnessed a 50 per cent rally in its shares last week when a better-than-feared trading update met with hedge funds forced into short covering.

As input costs rise, Mr Nicol thinks the testing of margin assumptions will drive share price reactions, as opposed to profit beats or misses.

Australia’s economic growth is expected to slow to 2 per cent in 2023-24 and inflation will hit almost 8 per cent later this year as rising energy prices heap further pressure on businesses, motorists and shoppers.

If the economy were to slide into recession, 2022-23 earnings could fall 10 per cent to 20 per cent under such a scenario on Macquarie’s numbers.

Citi projects a similar capacity for potential earnings surprises on the upside and the downside. The highest concentration of positive surprises are expected in energy, retail and technology. Negative surprises are more prevalent in metals and mining, steel and real estate.

Barrenjoey’s head of research, Craig Stafford, is watching for commentary on bank loan impairments saying share prices are “factoring in a goldilocks scenario”, namely higher interest rates translating into margin expansion.

“Data on an average level looks OK in terms of the buffers at the household level with higher rates, but it’s always dangerous to look at things at an average and I think you can break down mortgage holders into the haves and have-nots,” he said.

“The ones that don’t have good buffers, there could be some pain there for the banks.”

He, too, is hunting for further evidence of cost inflation at the big miners around labour, fuel and equipment. In the retail sector, Mr Stafford believes top-line growth at the supermarkets will be “in good shape” as inflation feeds into higher shelf prices.

He believes reopening trades like Qantas could surprise on the upside despite issues around customer service and the cost base as demand for oversees travel skyrockets.

While outlook statements are on watch, Morgan Stanley's Mr Nicol would not be surprised to see explicit guidance emerge as a “cameo rather than a feature”, noting that COVID-19 sanctioned the phenomenon of withholding guidance due to economic uncertainty.

“For those companies that can set a conservative range that is realistic and acceptable to consensuses, I think they will because that will be a point of differentiation.

“But I think most companies will err on the side of caution and talk more holistically around the changing outlook and what the risks are in that outlook.”

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