Earnings revisions: No sign of a trade war (yet)

In our view developed market equities remain in a benign de-rating phase, moving only sideways as profits rise and unconventional monetary policy is withdrawn. Critical to this view is a robust set of profits growth figures for 2018. Despite a significant slowing of economic momentum in the UK and Europe, consensus forecasts there still call for 8-9% 2018 earnings growth on a median basis. In the US, profits forecasts have seen another leg higher in recent months. The median US company is now expected to deliver close to 20% earnings growth in 2018. While there remain legitimate concerns and “headline risk” in respect of US trade policy, in our view and for the near-term, investors seem unlikely to dash for the exits with profits growth this strong.

Exhibit 1: Unweighted consensus earnings revisions index for 2018

As Exhibit 1 shows, there is relatively little to say about European earnings forecasts. Consensus estimates have remained remarkably stable on a median basis over the last 3 months and have risen on a weighted-average basis (not shown), in part due to currency depreciation over the period. This currency depreciation is in our view a belated reaction to the divergence in economic prospects between the US and Europe. Eurozone and UK economic surprises remain firmly in negative territory, Exhibit 2, while in the US the Atlanta Fed GDPNow forecast has risen to indicate 4.5% annualised US GDP growth this quarter.

Exhibit 2: Continued weakness in Eurozone and UK economic surprise indices

For US estimates, we note a helpful second leg higher in recent weeks. The US economy is perhaps sarting to deliver some of the benefits of the fiscal stimulus introduced at the turn of the year. Estimates rising this strongly would perhaps be expected to result in a very strong market performance. However, offsetting the positive news on profits is a US Federal Reserve which appears determined to continue on its path of normalising US monetary policy even as volatility builds in emerging markets. Yet despite this volatility, earnings estimates for emerging markets also appear to have stabilised in recent weeks after falling from the peak reached in Q1 18. Full year 2018 EM earnings growth is also still forecast to be over 15%, a figure which suggests that weaker EM performance may be due to investors re-positioning for a stronger dollar rather than fear of weakening corporate fundamentals.

While US trade policy may yet have significant ramifications, there is no observable effect on consensus earnings forecasts to date. The impact of a continued trade dispute would be significant however and escalation remains a risk but perhaps for 2019. Investors will take heart that US forecasts are rising again. We stick with a cautious outlook for developed market equities, not because we believe a major market decline is around the corner but because we see markets continuing to track sideways as monetary policy is normalised – but only if corporate performance remains as strong as it is now.