The pandemic has yet to ease but optimism in markets over corporate earnings is nearly unbounded. According to equity analysts, we should look forward to the biggest rally in global corporate earnings since 2003. Unfortunately, equity analysts are usually wrong.
The consensus predicts 50 per cent growth in earnings per share in Europe and 22 per cent in the US for next year, with the double-digit recovery extending into 2022 as laggards such as the financial and travel industries catch up. Recovery hopes are underpinned by expected global expansion in global domestic product next year of more than 5 per cent, the best since the 1970s, with central banks too fearful to withdraw support for stricken economies.
The third-quarter results season gave a hint of how corporate sales and margins will recover as vaccines roll out and economies unlock.
HSBC analysis found that 57 per cent of companies globally beat EPS expectations for the third quarter, slightly above the long-term average of 51 per cent. But it was the scale of the beats that impressed: by 22 per cent and 16 per cent for the US and Europe, respectively. Consumer goods, industrials, healthcare and technology were the star sectors, particularly in the US but also in Europe. For emerging markets, only the oil and gas companies stood out as regular consensus beaters.
Just as important, according to HSBC, were the outlook hints given during earnings calls. Its language analysis of more than 74,000 earnings transcripts suggested executives had turned most bullish relative to where they were three months ago among the technology, basic materials and industrials sectors. Only the consumer goods companies and financials remained gloomy.
However, with the Stoxx Europe 600 index already up more than 14 per cent for November, markets are already reflecting a lot of boardroom optimism. Valuations are now nudging 19 times 12-month forward earnings, well above the average since 2014 of 14.6 times, yet longer-term nominal growth prospects remain low, Goldman Sachs says.
Goldman’s global gross domestic product growth forecast for 2021 is about a percentage point above the consensus at 6 cent. However, the bank says that even if the recovery’s strength surprises and equities can hold on to much of their great reset premium, the market peaks seen in February are still unlikely to be bettered.
Earnings revisions are another complication. In recent weeks they have been going in the opposite direction to stocks, with investors choosing to ignore the present and peer through the fog. In the eurozone the picture for EPS estimates has been deteriorating for 10 straight weeks, according to JPMorgan Cazenove data.
The improving earnings picture has been driven almost exclusively by the US market, where the balance of EPS revisions has been in positive territory since June. For Europe, EPS downgrades have exceeded upgrades for every week of 2020.
A turnround in Europe looks challenged in the near term given November’s imposition of new lockdown measures. Few doubt the coming earnings rebound; when and from what base are the key unknowns.
Do markets offer any clue to the shape of the coming recovery? Not many. Market froth when measured by earnings expectations belies an awkward truth that forecasts are lowered for companies to beat. Equity analysts are notoriously over-optimistic and guilty of correcting their mistakes ahead of time.
For each of the past 19 years they have assumed the sum of corporate earnings would grow, which proved wrong four times for the US and nine times for Europe, JPMorgan analysis finds. Predictive powers have also been waning. Since the onset of the financial crisis in 2008, according to JPMorgan, start-of-year estimates have overshot reality 13 times for Europe and 11 times for the US.
Equity markets typically ignore over-exuberance on the sell side, as demonstrated by long-run average annual gains of around 10 per cent while EPS projections fell between 7 and 9 per cent. But markets have never before had to plot their way through the aftermath of a global pandemic. Nor has any current chief executive. A post-Covid-19 rebound looks a sure thing, but the odds have been lengthening that it can match recent exuberance.
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