Equity markets have bounced sharply in recent weeks, with the FTSE All-World Index up over 15% from its latest low as of early this week. Hope of progress on Europe’s debt crisis has been a key factor. Solid earnings reports in Europe and on Wall Street have also fuelled optimism.
On Wall Street, almost half of S&P 500 firms have reported on the third quarter. The index’s companies are on course to notch up an eighth successive quarter of double-digit profit growth. Earnings per share are up by almost 15% year-on-year. Thanks largely to financials, overall profits have exceeded expectations by 5.4%, notes Morgan Stanley.
Going forward, however, there appears to be less scope for earnings to deliver positive surprises. In the US, recent data have pointed to an uptick in growth in the third quarter, alleviating fears of recession. But this looks unlikely to last, as Capital Economics points out.
A one-off boost from car sales now that the global supply chain has recovered from the Japanese earthquake won’t be repeated. Also, US fiscal policy is set to tighten next year. And consumers have been dipping into their savings to keep spending, which is unsustainable. That is the only reason consumption hasn’t stagnated or contracted of late, says David Rosenberg of Gluskin Sheff. It suggests that the consensus estimate of a 12% rise in total S&P earnings per share in 2012 may be too optimistic. European forecasts are also vulnerable as recession continues to loom. Instead of an estimated 12% increase next year, look for European profits to shrink, says Morgan Stanley.
Quite apart from the macroeconomic backdrop, “it’s hard to see where extra profits are supposed to come from”, says Lex in the FT. US revenues exceed pre-crisis levels, and margins – which revert to the average over time – are at record highs, excluding financial stocks. And lower future margins aren’t just a cyclical problem for the developed world.
Rapidly rising wages in emerging markets “suggest that the period of buoyant corporate profitability, turbo-charged these past 20 years by globalisation and technological change”, has ended, says Jeremy Warner in The Daily Telegraph. “It will be either taxed, competed or costed away.” Given all this, earnings, hitherto a key boost for markets, look set to become a headwind in both the short and the long term.