Earnings revisions: Gap widens between U.S. equities and earnings forecasts

Though the bullishness is palpable, U.S. equity markets are not being driven higher by 2017 earnings forecasts, which have declined during November. In the absence of upgrades, we would now question how far the slogan of “Make America Great Again” can push U.S. equities. In the UK, market indices appear better supported as earnings forecasts are still increasing, even as the stock market has lagged. In Europe, in euro terms both the market and estimates have remained stable over the last quarter.

Although the Trump trade continues to power the market higher, U.S. earnings forecasts for 2017 have moved modestly lower since the election. A growing gap between a declining earnings trend and a higher market is likely to act as a brake on the market from current levels, unless closed with upgrades in relatively short order. In addition, we believe the rise in the trade-weighted value of the dollar, consistent with Trump’s policies of increased government spending and higher U.S. interest rates and bond yields, is likely to prove a further headwind for U.S earnings prospects.

Exhibit 1: Mind the earnings gap – US equities racing ahead of 2017 estimates

Despite the enormous uncertainties in respect of the Brexit process (including the recent High Court ruling on Article 50) UK earnings estimates are still moving upwards and at an accelerating pace. This is being driven by miners, pharma and industrials, and clearly linked to the continued weakness in sterling. There were few downgrades over the last month but the worst performer was retail, where the currency may be instead be contributing to margin pressure.

Exhibit 2: UK earnings forecasts on a rising trend – the sterling dividend continues

In continental Europe, both earnings forecasts and the equity market have been stable over the last 3 months. Though it is early days, we also note that following this period of underperformance European non-financials are now moving towards relative valuation levels against the U.S. which have been associated with European outperformance in the past, Exhibit 4.

Exhibit 3: Europe ex-UK: Little change in market indices or earnings forecasts

Exhibit 4: Europe ex-UK and US non-financials – valuations now pointing in Europe’s favour

Quick conclusions

1. U.S. equities are diverging from consensus earnings forecasts which have been revised lower over the past month. We recognise the short-term benefits of Trump’s “fiscal forward guidance” but believe profits forecasts will need to rise for the rally to be sustained.
2. UK equities are currently supported by rising forecasts, notably in the most international sectors such as mining and pharma following the devaluation of sterling.
3. Europe ex-UK earnings estimates remain stable and we would highlight the relative valuation position which has historically been associated with European outperformance.