Corporate profits – Too early to call an upturn

In today’s world of rock star central bankers it can feel like every move in the markets is down to the nuances of monetary policy. Last week’s ECB meeting was a prime example – EUR down on a larger than expected QE package and then minutes later a complete reversal as ever-lower interest rates were downplayed during the press conference.

But for equities we believe the silent killer of performance over the last 12m has been the mundane – that is very weak trends in corporate profits forecasts. For example, in western markets, forecast corporate revenue growth is now a fraction of what it was in previous cycles, having slowed to a crawl of 2-4% pa (more detail can be found in the November 2015 strategy insight).

Given this lack of sales growth, trends in forecast EPS intuitively become proportionately more important in terms of the direction of markets on a 3-6 month time horizon and this is certainly backed up by the recent correlation data. While we could easily point to, for example, the end of US QE as the reason markets have failed to make any progress over the last 12m, an even simpler narrative is that markets are following trends in forecast 2016 EPS, Exhibits 1-3.

Exhibit 1: US equities and 2016 EPS forecast

Exhibit 2: UK equities and 2016 EPS forecast

Exhibit 3: Europe ex-UK equities and 2016 EPS forecast

The equal-weighted data shown in Exhibit 4 emphasises that although the rate of decline appears to have slowed, EPS forecasts still show few signs of entering an upturn, even in the US where there has been something of a surge in positive economic surprises in unemployment and survey data recently. For investors taking heart from what in our view were important policy shifts from the ECB last week, earnings trends remain the Achilles’ heel of the equity investment case.

Exhibit 4: 2016 Forecast EPS trends (unweighted)

Quick conclusions
1. For the last 12m US, UK and continental European equity indices have closely tracked 2016 EPS forecasts. There has therefore been no meaningful P/E de-rating.
2. Based on the most recent data points it still seems too early to call an upturn in EPS forecasts but the decline rate has slowed in Q1 16.
3. The UK market perhaps looks a little overbought at present, if past trends are a guide, while continental Europe and the US appear in-line.

Sources for all charts: Thomson Reuters and Edison calculations