UK earnings trends – stable and few surprises

There has been much speculation in regard to the economic and market impact of the UK’s vote to exit the EU. However, even four weeks after the date of the referendum, there is no hard data to rely on. In the circumstances, survey data may also be misleading, with the risk that it reflects a projection of the personal views of respondents rather than a cold analysis of future prospects. However, early indications are that 2016 UK consensus earnings forecasts have remained stable, a continuation of the trend seen since February.

Exhibit 1

Exhibit 1: 2016 EPS revisions index for UK, US and Europe ex-UK

The sector analysis, Exhibit 2, confirms the direction of earnings forecasts is as widely anticipated – larger international companies have seen a positive benefit from sterling depreciation, offsetting downgrades in smaller or domestically focused sectors.

Exhibit 2: UK sector revisions post-referendum

The most important message from the data is that any downgrades are relatively modest, at least to date. UK banks suffered the sharpest sector downgrade since the UK’s referendum but this was only 4%. Other sectors which have been hit are domestically focused healthcare stocks (separate from global pharma), housebuilders and retailers, which as importers may be suffering from the move in sterling. On the positive side, mining and energy have shown the strongest upward momentum. It may be early days but we would suggest this is a very ‘normal’ set of earnings revisions which would not seem to justify some of the sharper downward moves in FTSE 250 names seen in the days after the referendum.

We would also highlight that recent trading statements, with a few high profile exceptions such as Foxtons and Easyjet, have tended to caution that it is too early to quantify the impact of Brexit. In contrast, if a sudden stop had been observed in current trading the incentive in our view would be to disclose it sooner rather later, so it could be attributed to the Brexit factor. Therefore while uncertainty remains high, we tentatively interpret this qualitative absence of a negative as a positive. The unwillingness of both the ECB and the Bank of England to immediately offer further stimulus is also telling in this regard.

Quick conclusions

1. It is still early days but analysts’ earnings revisions post-referendum seem inconsistent with a major sell-off in UK equities.

2. The 50bps reduction in long-term UK interest rates over the last six weeks would more than offset the modest reduction in earnings prospects, which may explain the much better than expected performance of UK equities over the past month.

3.In our view, UK equities are pricing in a modest reduction in growth prospects combined with looser monetary policy. The risk is that the Bank of England takes too much comfort from the lack of market distress and fails to follow through with the promised stimulus; a low probability scenario perhaps – but at current equity valuations we would caution investors are taking further stimulus as an article of faith.