By Philip Lawlor, managing director, head of global markets research
With the recent upsurge in global equity markets, investors seem to be looking beyond the bleak near-term earnings picture to the sunnier prospects farther out on the horizon.
Indeed, while “bottom-up” consensus 2019 EPS forecasts have suffered steady downgrades (with many now in negative territory), those looking for a robust global resurgence through 2021 have remained relatively firm (see the table below). The Russell 2000 is the pacesetter of this global recovery, with EPS expected to climb 37% in 2020, following a 3% drop this year. Asia Pacific is forecast for a similarly strong turnaround next year.
Source: FTSE Russell and Refinitiv. Data as of November 20, 2019. Past performance is no guarantee of future results. See end for important legal disclosures.
But how much credence should these forecasts be given? It’s a top-of-mind issue for investors in 2020 that we addressed in our November overview of global equity markets. While the macro outlook has improved somewhat, these lofty EPS expectations still look vulnerable.
Revenue growth enters "new normal"
As we posited in an earlier blog post, the already sharp drop in leading indicators and broadly accommodative financial conditions suggest that the worst of the global soft patch is likely behind us. Even so, the outlook for GDP growth across the largest economies remains anemic, with current 12-month-forward GDP growth projected to slow to 1.8% in the US and to 5.9% in China. Inflation expectations are similarly weak.
This still-weak macro backdrop bodes ill for future revenue and corporate profit growth. Indeed, as the chart below illustrates, most developed countries (except Japan) have entered a “new normal” of lower revenue growth in the 10 years since the global financial crisis. Lower nominal growth means lower revenue growth and, in turn, more pressures on operating leverage and, thus, future profit gains.
Source: FTSE Russell and Refinitiv. Data as of November 20, 2019. Past performance is no guarantee of future results. See end for important legal disclosures.
Beware of optimistic bias
Also bear in mind the optimistic tendencies in analysts’ bottom-up EPS forecasts, especially in the early stages. As the FTSE All-World consensus EPS estimate trails in chart below reveal, analysts’ forecasts since 2015 have tended to start high and gradually be revised lower over time. Those for 2019-2021 have seen persistent downgrades. One glimmer of hope is that 2020 EPS estimate revisions appear to have stabilized over the past few weeks.
Source: FTSE Russell and Refinitiv. Data as of November 20, 2019. Past performance is no guarantee of future results. See end for important legal disclosures.
With 12-month-forward price/earnings multiples currently at premiums to their 10-year averages across most developed equity markets in both absolute and relative to the broad world index, equity markets appear to have much at stake in how the profit cycle unfolds in the coming months.
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