It can hardly be a surprise, given the recent sharp declines in PMI indices on a global basis, that 2019 earnings forecasts have once again started to decline. Markets have rallied since Mario Draghi’s dovish commentary last week, which was quickly followed by a bullish interpretation of the US Federal Reserve’s interest rate decision. However we believe investors also need to pay attention to weakening trends in corporate profits which are likely to persist in our view, at least until PMI indices turn higher.
Ex 1: Unweighted 2019 earnings revision indices have declined in prior 6 weeks
Source: Refinitiv, Edison calculations
Until the end of Q119, the equity market rally had been built on easier financial conditions, in terms of lower interest rate expectations in Europe and the US, but importantly also a recovery in confidence for corporate earnings prospects for 2019. At the end of Q119, estimates stabilised after falling for six months starting from October last year.
This improvement in profits expectations is at risk of proving unsustainable, in our view. We believe investors will have to see real progress in respect of the key political uncertainties of the US/China trade conflict and the UK’s exit from the EU. On the surface, the rhetoric from the US administration in terms of China has softened somewhat over the past week and it appears that a meeting at the G20 later in the month will now include a presidential meeting between the US and China, at the request of the US.
However, the incompatibility between the positions of the US and China, particularly in respect of any US willingness to allow China to compete for global leadership in high-tech industries remains a glaring obstacle to meaningful progress in talks. While uncertainty on trade may have contributed to a slowdown in global trade volumes, US tariffs are now in place and the corporate sector, both in China and the US, is already taking steps to re-configure supply chains to avoid the risk of supply disruptions.
Brexit may at this point have been pushed out of the headlines, as the UK’s ruling Conservative party selects a new leader and Prime Minister, but the issue of the UK’s exit from the EU remains wholly unresolved and is likely to create increased market volatility later in 2019. We note, for example, that the median UK earnings forecast is a full 10% lower than at this time last year, at least in part reflecting Brexit uncertainty.
The relatively open eurozone economy is suffering from both these negative political developments with recent PMI readings well below the 50-level which separates contraction from expansion. It is unfortunate timing for the ECB, as no successor has yet been anointed to replace the incumbent ECB President Mario Draghi. Both growth and inflation expectations have been on a downward trend in the eurozone since mid-2018, which may have somewhat forced Draghi’s hand to deliver a very dovish speech in Sintra last week, unfortunately attracting the ire of the US President in the process. What was in our view more significant than the US political interference were the later press reports which indicated that there is at the present time limited consensus on a way forward within the ECB’s governing council.
We remain uncomfortable with near-term equity market dynamics being driven almost entirely by short-term changes in the outlook for monetary policy when profits growth is the larger component of equity returns in the longer-term. Corporate profits are now forecast at a rather pedestrian 5-7% growth for 2019 in developed markets. Emerging market growth forecasts for 2019 have now fallen 9%, compared to 15% a year ago.
We have to acknowledge that we have been surprised by the recent level of excitement within equity markets for some quite predictable shifts in the official outlook for interest rates in the US and Europe, which in large part adjust policymaker’s views towards earlier market expectations. Nevertheless, we remain of the view that global equity markets are unlikely to make material progress without the fundamental support of confidence in profits growth. Equities remain at risk from further reductions in profits forecasts in our view, reflecting the declining momentum in global survey data.