One of the key drivers of equities during H1 2017 was the relatively strong level of earnings momentum in each of the US, UK and continental Europe. This was in some respects a carry-over from the surge in positive sentiment towards the end of 2016 but which now appears to have run its course. It is easy to forget that as recently as 18m ago, investors were anticipating a major calamity in China’s economy, sharply impacting sentiment in the basic industry and other cyclical sectors which in the event did not occur. However, the data now highlight a modestly declining trend in 2017 earnings forecasts since mid-year, even as economic sentiment remains robust.
After a steady start, our equal-weighted earnings revisions indices in each of the US, UK and Europe ex-UK have been drifting lower since June, Exhibit 1. Even if the declines are to date modest, the lack of upward momentum is in our view contributing to flat-lining markets since the summer. The figures are also in contrast to PMI indices which point towards accelerating growth into Q3, highlighting the reluctance of the corporate sector to raise guidance on increased economic optimism.
Equity markets may have been jostled by rising tensions between the US and North Korea in terms of geopolitics but the data suggest improving underlying corporate performance is no longer the driver it was previously. We view the equal-weighted measure as a better indicator of the overall direction of earnings estimates as this index is not dominated by only a few very large cap companies.
From a sector perspective, the pattern of revisions suggests that a degree of weather-related disruption may have impacted US forecasts for Q4, Exhibit 2. Downgrades have been concentrated in transport, oil services, insurance, housebuilding and construction for example. If purely related to the weather, we would expect to see these downgrades either reverse or be recovered in 2018 forecasts. However the trend bears watching – these sectors are also among the most cyclical and weather related impacts should in theory dissipate in only a few weeks’ time.
Near-term economic momentum has however improved, as indicated by economic surprise indices moving higher after a lull earlier in the year (Exhibit 3). This is the data emboldening central banks to retreat further from ultra-loose monetary policy. The divergence between the economic data and consensus earnings forecasts is intriguing and could even suggest that at present what is good for the economy may not necessarily be good for corporate profits.