This crisis “just isn’t comparable to previous recessions”, says Gerald Blank of Blank Asset Management in Wirtschaftswoche. The markets are beginning to understand this. Cratering profits and continual downgrades to economic and earnings forecasts are undermining confidence and have sent most major markets to fresh multi-year lows of late. Global growth looks poised to shrink this year for the first time since 1945. The first quarter saw S&P 500 companies notch up their first-ever collective loss. Even if you exclude financial stocks, profits were negative, says James Bianco of Bianco Research.
The consensus estimate of UK earnings per share over the next 12 months has fallen 28% in six months, says Morgan Stanley’s Graham Secker. On a global scale, analysts are factoring in a mere 8% earnings decline this year, having begun 2009 expecting a 1% fall. But a 30% drop seems more realistic, says Citigroup. The deluge of downgrades, which needs to abate before there can be a sustainable recovery in equities, is unlikely to end anytime soon. It will be some time before markets can start to look forward to a recovery.
Secker, meanwhile, is now forecasting a 60% peak-to-trough earnings fall for the bank- and oil-heavy British market across 2008 and 2009. This is marginally worse than the 57% slide seen in the 1930s, and may sound “draconian”. But remember that profits posted their biggest five-year increase on record before this downturn. “It is not unreasonable to also expect the biggest bust.”
Assuming a 60% earnings fall, what might this mean for the market? We can get an idea from the p/e multiples typically seen when earnings bottom. Secker notes that the average trailing p/e ratio in Britain at previous earnings troughs has been 14.6. Plug in the earnings figure represented by a 60% slide and this implies a FTSE at 3,700.
But given the shocking state of the global economy and financial system, investors may pay less for trough earnings and profits could fall even further. A trough p/e of 12 and an earnings decline of 70% implies a FTSE 100 level of just 2,300. It’s also worth noting that the cyclical p/e ratio, which uses the average of the past ten years’ profits, is not yet at the single-digit levels of past major bear-market bottoms. The FTSE may be down by 50% from the top, but it still doesn’t look safe to jump back in.