The Financial Times’ Lex column today, in reflecting on the coming anniversary of the 1987 crash, dashes cold water on those who continue to be optimistic about corporate earnings.
Independent of the outlook for housing, it seems quite remarkable that analysts can come up with forecasts of meaningful aggregate increases in earnings over the next year. The only cause for cheer would seem to be the falling dollar, which will boost foreign earnings of multinationals, but too dramatic a fall would be destabilizing and thus a potential negative.
Moreover, our colleague Susan Webber has pointed out that large companies have hit their numbers not by virtue of making great products or finding new markets, but too often by cost cutting. Done on a sustained basis, which it has been, that is tantamount to disinvestment.
And on an anecdotal level, everyone I know who is in still in the saddle in a major corporation seems to be doing at least a job and a half. Again, the ability to wrest more productivity from workers (absent investments in equipment or process improvement) may be at its limit.
From the Financial Times:
Three months ago, analysts expected S&P 500 earnings to rise by 6.2 per cent in the third quarter. A few days into the earnings season and that has been whittled down to zero, according to Thomson Financial. Financial companies have been hit by the credit turmoil and billions of dollars of write-downs. That has reduced sector estimates from 9 per cent growth in July to a decline of 8 per cent. Consumer discretionary stocks have also been slashed from 3 per cent growth in July to a fall of 7 per cent. Overall, earnings have been mixed for the companies that have already reported.
Analysts still expect the quarter to be a blip, with growth bouncing back sharply in the final quarter – again led by technology and healthcare, fuelled by a rebound in consumer discretionary and energy companies. But investors must remember that US corporate profits as a percentage of gross domestic product are already at their highest level for decades.
Some comfort can be taken from the fact that about one-third of S&P 500 earnings now come from overseas, where economic growth remains robust. And the market trades on a trailing price/earnings ratio of about 18 times, according to Datastream – pretty reasonable in the context of the past 20 years.
In 1987, when the trailing p/e reached 22 times, conditions were very different. Risk-free yields were far higher, interest rates were rising and profits surging.
Today’s “p” looks superficially attractive for equity investors. But they are showing an unhealthy level of confidence that even in the face of a wobbly economy, the “e” they are relying on is not about to return to anywhere near normalised levels in the near future.