Any hopes that investors had of earnings growth salvaging what is poised to be the first down year for stocks worldwide since 2011 are quickly fading.
Cuts to profit estimates outnumber increases by the most in three years, and the pessimism could reach levels last touched during the financial crisis, based on an index tracking the changes compiled by Citigroup. China’s slowdown, a fragile recovery in Europe, and disappointing US economic reports are combining to jeopardise one of the key drivers of a bull market in which stocks rose as much as 156 per cent since 2009.
“Fundamentals aren’t great anywhere,” said Peter Dixon, a global equities economist at Commerzbank in London, who recommends trimming allocation to stocks. “It has become a fairly difficult background for corporates to operate. Valuations will start looking more stretched, and a lot of people are beginning to wonder whether we’re nearing a wider correction.”
While declining oil prices are to blame for a big chunk of the profit reductions this year, especially for American companies, the latest round of cuts reveals a deeper issue.
Evidence that emerging markets from Asia to South America are suffering just as enthusiasm over the US economy fizzles has caused economists to trim their 2015 global growth forecasts to just 3 per cent, which would be the least since 2009, from 3.6 per cent last year. They currently project an expansion of 3.5 per cent in 2016.
Citigroup’s earnings-revision index, a measure compiled weekly that shows the number of analyst downgrades versus upgrades to global profit estimates, dropped to minus 0.39 in September, the lowest level since July 2012. That is down from a high this year of minus 0.03 in May. In 2009, the gauge reached minus 0.62 and averaged minus 0.28 in the first half of the year.
Data compiled by Bloomberg show earnings at companies worldwide will climb about 4 per cent this year and 10 per cent the next. Forecasts for 2016 are too high, Citigroup indicated in a report last week. The bank says that a drop of 3 per cent is likely if the global economy slows to 2 per cent, a scenario it considers possible.
After years of resilience from corporate America, analysts project earnings for Standard & Poor’s 500 Index members will be flat this year. That would be the worst performance since 2008, before an estimated rebound of 9.4 per cent in 2016. Profits are forecast to increase 4.8 per cent in Europe this year, down from the 11 per cent predicted in March, and will fall 5.8 per cent in the emerging markets, according to Bloomberg estimates.
The rally that has lifted equity valuations since 2009 with the help of aggressive central bank stimulus is now fading as the Federal Reserve prepares to raise interest rates. After rising to a five-year high of 18.5 times earnings in April from 11.1 in 2009, the MSCI All-Country World Index’s price-earnings ratio has slipped to 16.4, near its level from last October. In less than four months, global equities have lost $12.6 trillion in value.
The gauge for global stocks is down 9.3 per cent for the year yesterday.
“You can’t expect multiples to expand much further from here,” said Andrew Parry, head of equities at Hermes Investment Management in London. “A lot of people believe that US profits have peaked, while exporters around the world will struggle to find demand in emerging economies. Slowing growth is problematic in a world of higher rates.”
France’s L’Oreal forecast that growth in the cosmetics industry will be at the low end of an earlier estimate. The Swiss miner Glencore trimmed the earnings outlook for its trading division as commodities kept on falling. Caterpillar and FedEx cut their annual projections, while the South Korean giant Samsung Electronics lowered prices for some of its smartphones to combat weakening demand.
One bright spot is Japan, where profits will probably jump 20 per cent. Just as a stock market boom since 2012 helped banks to reap higher profits, a weak currency continues to bolster earnings for exporters such as Toyota Motor. The yen reached a 13-year low versus the dollar in June.
Bulls may take comfort from cases where scepticism was proved to be overblown. US first-quarter earnings unexpectedly held strong against a rising dollar and plunging oil prices, while the pace of Europe’s economic recovery, even though fragile, is still on track.
Yogi Dewan, the chief executive of Hassium Asset Management, says the earnings cuts have been too deep and recommends investors take advantage of the sell-off.
Excluding energy stocks reveals a better picture. The remaining S&P 500 companies will increase profits by 7.1 per cent this year, analyst estimates show. And while Morgan Stanley expects European earnings to be flat in 2015 – down from predictions earlier this year for 12 per cent growth – removing commodity-related shares means they will probably increase by an average 9 per cent over the next three years, according to a note last month.
“The market has turned too pessimistic,” said Mr Dewan, the founder of Hassium. His firm manages about $1 billion. “Yes, we may get a slowdown from emerging markets, but the US will compensate for that. Things aren’t that bad. We’re in for a round of earnings that will be enough to support higher equity prices for 2015.”
Evidence of strong profits would offer relief for global stocks, which have dropped 7.3 per cent in the third quarter as measured by the MSCI All-Country World Index. Alcoa unofficially kicks off the US reporting season next week, and analysts project an average 6.5 per cent decline in S&P 500 company earnings for the period.
“We need to see if corporates can withstand the growth shock,” said Chris Faulkner-Macdonagh, a market strategist at Standard Life Investments in Edinburgh. He recommends selling US stocks in favour of European and Japanese equities. His firm manages $379bn.
“Though the underpinning for Europe and Japan is still in place, fundamentals there have gotten weaker just as emerging markets struggle and the US endures weak prospects for top-line growth. Things look shaky.”
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