Are earnings projections low enough?

OK, the market is in a terrible hole. But the question is what has the market priced in and how accurate is it? No earnings growth at all in the case of Rio and BHP, and precious little growth across the market more generally. Such bearishness has proven close to the mark, but it is worth watching for significant mis-pricing. Deutsche notes that the downgrades continue, although their rate has slowed:

Over the past month earnings forecasts were cut for 117 ASX200 companies, compared to upgrades for 68. This is the best ratio in 6 months, but is still below long-run averages. More concerning is the plunge in earnings revision ratios globally. As an example, for every S&P500 company having earnings forecasts upgraded, there were almost three seeing downgrades, the worst ratio since March 2009. The chart below shows that equities haven’t tended to rally sustainably until the worst has been seen, though this may not be too far off.

Deutsche says earnings growth will be 14% this financial year, falling to 13% next year:

Consensus aggregates appear distorted by issues such as recent demergers, and consequently understate growth. On our estimates, consensus is looking for 14% EPS growth in FY12, with resources again expected to be the driver. The market PE ratio of 10.8x (7% below the 18m average) suggests skepticism amongst investors that this growth will be delivered. We estimate that consensus is looking for 14% growth for industrials in FY12, but 12% excl. Leighton. We retain our view that this will drop to 5-10%. Banks are expected to grow earnings by only 3% in FY12, which looks easily achievable. Still, with recent outperformance banks are looking less cheap. Resource  valuations look attractive, but there is considerable near-term uncertainty around the direction of key commodity prices.

Once again, the momentum comes from resources. Which means China drives our market. Which means Australia’s two speed economy is something like a microcosm of a two speed global economy. Which means uncertainty is still high.


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  1. i like the quote from figure one “equities pick up when the worst of the downgrades have pased” and COULD NOT AGREE MORE.

    the worst of the downgrades have passed (ie everyone gets to bearish at the bottom) which is why the market is picking up.

    the ratio of downgrades to upgrades for the ASX is back at 2009 lows. and we know what happened after that….one of the biggest most profitable rallies in shre market history.

    good post. thanks

    • SkoptimistMEMBER

      “i like the quote from figure one “equities pick up when the worst of the downgrades have pased” and COULD NOT AGREE MORE.”

      This sounds like a fairly circular argument. i.e. things start getting better when the worst has passed.
      Well, if they were getting worse then the worst wouldn’t have past, would it?
      How do you judge where we are now?.
      At the first of many troughs or at the bottom?. Only time will tell.

      With the largest economies all heading into recession (not out from), you must be pinning most of your hopes on Asia.

      Bad debts, or soon-to-be bad debts, seem to be everywhere.
      Lets hope you are right.

  2. GB, I admire your optimism. I would like some of whatever it is you’ve been smoking, because I see the world completely differently.

    From my perspective, the Euro economic order is doomed. Serial sovereign defaults are just inevitable. Even attempts to restore growth (which in any case will not work) will only exacerbate the structural imbalances in Euro-zone economies – that is, a return to growth would accentuate the external deficits of the debtor economies, increase inter-country liabilities and magnify the eventual losses in the private financial sector.

    It follows that the Euro banking system – already essentially insolvent in all but name – will certainly fail. This is inescapable. So the prospect is for the world’s largest economic zone to nose-dive into deflation, mass contraction and prolonged dislocation.

    Demand destruction in the real economies and disorder in the financial sector will be transmitted to non-Euro economies in epidemic proportions.

    This is all just completely inevitable unless systemic reform is undertaken in the European financial system more or less immediately. Since this is essentially impossible, chaos is only a matter of time.

    • I don’t agree. There will probbaly be at least one default in the Euro zone, and I wouldn’t be surprised if more than one country leaves the Euro, but I doubt that the region will collapse altogether. It’s far likelier that there will be a series of ups and downs lasting several years, until the worst offenders have taken their medicine. Numerous band aids will save the rest from any major embarrassment.

      In the meantime, the market will be highly volatile. This is uncertainty at work, nothing more. It won’t go away any time soon.

    • oh here we go again, “euro economic order is doomed”. you need to read that back to yourself before hitting the reply button to see how silly it sounds. I hate to break it to you but the world as we know it is not going end. and none of the stuff you mention is news anyway so you really think this stuff isnt already in the price by now?

      All i can say is this, if you beleive what all the group thinking analysts beleive, and at the moment they share your veiw, you will never make any money in the stock market.

      just like i bet you didnt make any money in the stock market last month when until the last hour of trading the market was on track for its best month in 20 years. ill show you my trading account for october if you show me yours.

      • Epeening much GB?

        It’s interesting that you say the bad news is already priced in. If the market were really that efficent then why are they continually surprised by events in Europe? I mean none of this was news in April when the ASX was around 5,000 points.

        For myself I sit somewhere between Briefly & PhilH’s views but I am bearish on the ASX although I was still happy to go long in Oct and no you can’t see my trading account!

      • GB, I have been out of the market since April. I am too old, too slow (and not well enough) to lose any savings, small as they are.

        I have been thinking about the Euro situation a lot. The markets have their own dynamics and will fluctuate, presenting opportunities for those game to trade. There’s no doubt about that. If you jump in, good luck to you.

        But equally, the Euro system is very badly structured. Defaults are inevitable. The Euro banking system – a heavy lender to crippled sovereigns – is essentially insolvent in all but name. So while the system can be propped up and generally held together for a while, before long it will cease to operate. It will fail.

        People seem unable to grasp this, but in the era before the development of modern central banking, economic collapses were common. The structural contradictions in Euro economies and the separation of fiscal structures from monetary agencies, taken together, will generate continuing crisis in Europe.

        That is the thing. Euro-crisis is no longer exceptional. It is a function of the design of the system.

        But I do wish you luck with your trading. I’m sure there is a lot of money to make.

  3. With the situation in Europe looming over everything and no resolution there, the fact the US still has to address it’s own issues, China issues, Japan issues etc… it is hard to see past a bearish view.

    Maybe that should be a sign to get in, after all the night is darkest just before the dawn, but I still can’t get past the fact that a lot of underlying issues have not been addressed and only band aid solutions have been applied. Tough decision keep getting kicked down the road for the next person/politician/generation to deal with.

    So for now, I can’t see where the bullish case comes from other than hope and hope is not an investment strategy, so I’m mostly cash 🙂

    • I wonder what will happen if the Fed springs a surprise and unveils a massive QE3 tonight (I think they meet tonight?). It would be interesting to see how that counters the European situation. But aside from QE3 it’s kind of hard to see a driver for a new bull market (globally). Most countries have exhausted their stimulus bullets and some are enacting austerity. I think we’ll go lower before we go higher (unless we get QE3).

      • Yeah I guess it could be a driver but don’t think it will happen unless Europe really goes bang, if at all.

        Again though, it is only a band aid solution. I would still be bearish. QE has to end some time and the fundamental issue would still be the same – excessive debt.

        Plus can helicopter Ben really justify QE3 if inflation is already starting to kick off and signs of a strongish 4th quarter?

    • “it is hard to see past a bearish view.
      Maybe that should be a sign to get in”

      totally agree with this shay, id go with your gut rather than the always wrong crowd. succesful contarian investors always outperform the trend followers

  4. Unfortunately, the last round of Q-E seems to have caused a spike in energy costs, nearly derailing the recovery in the US in Q1. Putting extra cash into banking system reserves does not seem likely to help a whole lot. But some form of debt-forgiveness in the mortgage market could really help a lot. One-quarter of US mortgages are under water and will stay that way for decades.

    Of course, granting a Fed-financed write-down to the mortgaged is one thing, but it invites all the non-mortgaged to ask, “What about me?”

    There needs to be an economy-wide fiscal and monetary re-booting in the US, but it is not looking very likely to happen.


    This reflects cyclical deceleration in global industrial output. But it also reflects the pursuit of austerity in Europe. Austerity is the wrong policy, but at the same time it appears to be the only policy available in the Euro system.

    So now we have a cyclical downturn that will be amplified by deflationary processes. This is a direct result of system design and is intrinsically pro-cyclical and self-extending.

    This is bad enough. But the situation is actually even more difficult than it appears, because even if growth could somehow be revived in the debtor economies, because they are in external deficit, the magnitude of the imbalances with which they have to deal will increase.

    The debtor economies are just trapped. They cannot grow their way to fiscal balance. They cannot shrink their way to fiscal balance. Nor can they remain stationery because they are already at or past “the tipping point” between fiscal stability and ever-spiraling debt.

    Because they do not issue their own currencies and cannot go through devaluation and reflation, they have condemned themselves to internal deflation. They are going to eat themselves alive.

  6. Yeah briefly, there area a lot of structural problems in Europe and that is what worries me. I have just come back from ireland and i have seen first hand the problems austerity measures are causing but with the excessive debt, they have no choice currently.

    Defaults occur not just due to an inability to pay, but also due to an unwillingness to pay. Seems like we are getting close to that point with Greece. And then the fun begins and I have no idea what the consequences will be.

    I guess the way I look at it is when was the last time any politician came up with a decent solution to anything?? I’m not holding my breath on anything in Europe.