Author: Alastair George
Consistent with the weakness in global PMI survey data, we find that a weakening trend in 2019 earnings forecasts has taken hold. We recognise that for many investors corporate fundamentals will matter less than the near-term direction of monetary policy at the present time. However, slowing economic growth does appear to be having a detrimental effect on profits momentum. On an unweighted basis, 2019 forecasts are now 10% lower than a year ago in the UK and eurozone and nearly 15% lower in emerging markets. The US has held up better with a 3% decline in earnings forecasts over the same period.
Having stabilised during Q119, earnings estimates in both emerging and developed markets are back on a declining trend as the impact of the US/China trade dispute continues to bear on the global economy. This has been reflected in weakening trends in PMI survey data for some time and is now feeding into corporate guidance and consensus earnings forecasts.
For now, market direction appears dominated by the prospect of easier monetary policy although we note that historically equities have typically struggled in an environment of downgrades. We are concerned that investors are not properly taking into consideration the strong likelihood of lower profits in a scenario of lower economic growth – which is implicit in expectations for meaningfully looser monetary policy. Even as earnings forecasts are now falling at a similar rate to that seen in Q418, equity market sentiment has for now remained remarkably robust.
Given the rise in forward valuations in the US for example, we estimate that there has been a 0.5% reduction in the equity risk premium for US equities in recent weeks, which is similar to the reduction in the spread between junk bonds and US government securities over the same time period.
This represents in our view a touching faith in the ability of central banks to use monetary policy to support an economy buffeted not by credit availability or financial stability concerns, as was the case earlier in this cycle, but instead by adverse geopolitical developments such as US/China trade policy. We therefore continue to be surprised by the resilience of equity markets but maintain a cautious outlook as we believe the good news on monetary policy is in the price while the incoming profits downgrades may yet weigh on performance.