Profits will disappoint

QE-addicted markets were "denied their fix" by US Federal Reserve chairman Ben Bernanke last week, says James Mackintosh in the FT. They were hoping for a third dose of QE (quantitative easing), or printed money. The first two were accompanied by rallies in equities. But no QE3 was announced, although the Fed is set to meet earlier than usual next month, and may yet unveil some new measures.

As we pointed out last week, however, previous doses of QE had scant impact on the economy, and there's no reason to believe another shot would amount to anything more than "smoke and mirrors", says Stephen King in The Independent. The market's reliance on the Fed seems to have led them to neglect another key issue: earnings forecasts are too high.

Markets have "lost some froth" in recent weeks, says Mackintosh, but profit estimates haven't. In America, analysts are still pencilling in overall earnings for the S&P 500 of $108 a share, higher than in 2007. "They remain unprepared for even a relatively modest 20% decline in profits typical of a slowdown, let alone the 30%-40% reductions in profit outlooks that would accompany a recession."

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Economists have rushed to lower their forecasts as the data have turned ugly, but analysts have barely trimmed theirs, adds Nelson Schwartz in The New York Times.

The latter expect S&P 500 earnings to grow by just under 16% year-on-year in the third quarter. In early July, that estimate stood at 17%. It's a similar story for the fourth quarter. The gap between economists and analysts has rarely been wider. Bloomberg.com's Whitney Kisling says that analysts are, on average, expecting profits to grow ten-times faster than the economy this year. Since 1954, the average gap has been 5.4 times.

"If we're in for weak growth and this raises the risk of a recession, it's inevitable" that profits will be affected, says Nick Sargen of Fort Washington Investment Advisors. "Analysts will be bringing down their earnings projections." The same goes for Europe, where outlooks remain "unrealistic", says Morgan Stanley. Indeed, the forecast 2012 profit growth rate has actually ticked up over the past month. So there is ample scope for disappointment in equity markets over the next few months. As Joseph Cotterill puts it on FT.com, "consensus beware".