Earnings Revisions: Waiting for upgrades?
Though global equities continue to benefit from significantly increased investor optimism, US and continental European earnings forecasts for 2017 have remained stubbornly static over the last 3 months. However, in the UK 2017 earnings estimates continue to move higher, tracking the decline in sterling and providing a degree of fundamental support for the FTSE100. For US and continental European equity markets, the increasing divergence between 2017 profits forecasts and their respective price performance, when added to the lack of valuation support, puts a question mark over how much further the rally can run.
Exhibit 1: US – 2017 EPS forecast revision index
Exhibit 2: Europe ex UK – 2017 EPS forecast revision index
Exhibit 3: UK – 2017 EPS forecast revision index
We believe it is unlikely that US and continental European markets will continue to run higher in the absence of upward revisions to profits forecasts given already very high valuations. In this respect, the recent series of positive economic surprises on a global basis is notable, Exhibit 4. This data is clearly in contrast to flat-lining earnings forecasts, which in our experience tend to marginally lead the economic and survey data.
Given the lack of upward momentum in earnings forecasts, we therefore tentatively conclude that macroeconomic forecasts may have been too pessimistic at the start of 2016 given the headline political risks during the year and the resulting positive economic surprises may not in fact translate into earnings upgrades. However, this view can only be confirmed with more data which means an uncomfortable waiting period for equity investors may lie ahead.
Exhibit 4: Citi economic surprise indices surging from H2 16
For US and continental European equity markets, the increasing divergence between 2017 profits forecasts and their respective performance, when added to the lack of valuation support, puts a question mark over how much further the rally can run. While we acknowledge there will be investors who will take heart from the significant improvement in the economic surprise indices, we still believe it is better to commit capital during periods when economic and investor sentiment is much weaker than at present.
