Why earnings forecasts are too optimistic
Third quarter operating earnings slid by 8.5%, according to Merrill Lynch. Yet forecasters are pencilling in a very speedy recovery. Can stocks really bounce back that fast?
"The profit miracle is over," says The Economist. Since 2002, earnings growth has been in double digits, but in the third quarter operating earnings slid by 8.5% year-on-year, according to Merrill Lynch.
Yet forecasters are pencilling in a "remarkably" speedy recovery. Earnings are expected to expand by 14% next year, with every single sector posting gains; in the first half, when America could be in recession, the annual rate of expansion is predicted to be 9%.
These forecasts "border on the hallucinatory", says Tim Bond of Barclays Capital, in the FT. The consensus call is for economic growth to average 1% for the next two or three quarters, and growth at this rate is historically associated with a decline in operating profits. "Equity markets are also oblivious to the severity of the credit crunch".
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
A quick rebound in financial sector earnings, which comprise about 30% of the S&P 500's overall profits, is hardly realistic, given rising mortgage delinquencies, gummed-up wholesale markets and a likely increase in corporate defaults as lending and the economy slows. High profit margins are contracting as labour costs rise and pricing power falls.
Predictions for global earnings, forecast to expand by 12% in 2008, also look pretty optimistic. After all, the consensus anticipates a slowdown in the world economy. And profit margins, which tend to revert to the average, reached record peaks this year, says John Authers in the FT. Markets look set for disappointment as earnings estimates "steadily fall subject to financial gravity".
Sign up to Money Morning
Our team, led by award winning editors, is dedicated to delivering you the top news, analysis, and guides to help you manage your money, grow your investments and build wealth.
-
8 of the best houses for sale with libraries
This week: the best houses for sale with libraries – from a five-storey Georgian townhouse in Bloomsbury, London, to a 15th-century property with a library in a medieval tower in Lozère, France
By Natasha Langan Published
-
Investors pull money from UK equities as government warns of “painful” Budget
The government’s post-election honeymoon period has been short-lived, and investors are shying away from UK equities as a result
By Katie Williams Published