COLUMNISTS We have reached the season when brokerage houses release their forecasts for next year. A gaping disjunction is emerging.
Expectations for the economy are not positive – although the consensus is for a slowdown, rather than a recession. According to Citigroup – others have similar numbers – economists expect 3.4 per cent growth for the world in 2008, down from 3.7 per cent this year. All the major markets will slow down, with the exception of the US, which will rise from 2.2 to 2.3 per cent.
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John Authers on disjunction between earnings forecasts and economic outlook
The disjunction comes when we look at earnings. According to Thomson Financial, “bottom-up” analysts are calling for company profits to rise 11.8 per cent next year, faster than the 9.4 per cent rise they expect this year. The eurozone will suffer the slowest earnings growth, of 7.8 per cent – still fine in an economy that will supposedly only grow by 1.9 per cent.
In the US, where bonds now price in the risk of an outright recession, earnings will next year somehow grow by 14.9 per cent. Earnings growth in this quarter was negative.
Economic growth and profits do not necessarily go hand in hand. Companies can make money during a recession, if they increase their margins. But profit margins, which tend to “revert to the mean” over time, had been at all-time highs before financials suffered losses in the third quarter.
Plainly, therefore, analysts’ and economists’ forecasts are irreconcilable, even if financials stage a strong recovery from the credit squeeze.
The news is not quite as bad as it seems. The disjunction has been noted, and so stocks may be trading on assumptions that are more realistic than the apparent consensus. But it does mean that stocks, particularly in the US, may not be as cheap as they first appear, and the market is set up for difficulties as analysts’ estimates steadily fall subject to financial gravity.
