Economic forecasts for 2005 may have been revised down but the impact on corporate profit forecasts have so far been mixed. Are the economists getting it wrong or are analysts displaying their normal over-optimism?
Figures from Dresdner Kleinwort Wasserstein show that 2005 earnings forecasts were revised up by 0.5 per cent last month. But this aggregate number was boosted by big upgrades for the oil and gas sector, thanks to higher crude prices. Without that industry, the trend would have been down, since two out of three sectors saw forecast cuts.
Excluding the US, global forecasts were revised down by 0.4 per cent for the current year but up by 0.3 per cent for 2005. Again, oil was responsible for the upgrade. But the picture was rather more upbeat than in the US; 17 sectors experienced higher forecasts (including mining, chemicals and construction) while 15 (including electronics, technology and food producers) saw cuts.
For markets with big exposures to oil, the effect has been very positive. The UK has seen six successive months of upgrades, during which five percentage points have been added to 2005 forecasts.
But there is an obvious irony. The same high oil prices that are causing economists to revise down their growth forecasts (and are pushing up costs for many companies) are leading to a net upgrade to profits forecasts.
The traditional path for earnings forecasts is that they start the year high and get revised lower as grim reality sets in. But that has not been the case for much of the last 18 months. Corporate profits, particularly in the US, have tended to surprise on the upside, as companies have delivered strong productivity growth without pushing up labour costs.
But profits now look high in relation to US GDP. Even without a slowdown in economic growth next year, the profit record seems likely to deteriorate.
What may be comforting to equity bulls, however, is that the stock market has been pretty flat this year, despite the surge in profits to date. This suggests that investors have been “looking through” the good news in anticipation of a deterioration in 2005. So even though analysts’ forecasts for 2005 may eventually head down, some of the bad news may already be in the price.