Opinion | Columnists
A different story that US numbers tell
The US earnings season has just lurched over the halfway line. It is fair to say, however, that the attention of investors has been elsewhere.
- Financial Times
- Published: 00:23 November 4, 2008
The US earnings season has just lurched over the halfway line. It is fair to say, however, that the attention of investors has been elsewhere.
Given the volatility in equity markets, it is also clear that stock prices are not reflecting, as they should, considered estimates of the present values of companies' future dividends.
At the end of the day, earnings, adjusted for the return required by investors, determine a company's value, all else being equal. What do the numbers say so far?
The reality is that corporate America is not yet suffering too badly. Obviously, overall earnings growth fell during the third quarter compared with last year.
But the average drop of 6 per cent - adjusting for market capitalisation and excluding one-offs - is not so bad. If financials are excluded, earnings actually grew by 15 per cent. In summary, banking horrors were balanced by good results elsewhere.
But that is history - where are US equities heading now? Many reckon the market is cheap. Looking at long-run price/earnings ratios (adjusted for inflation and using 10-year average earnings) Capital Economics estimates that the S&P 500 is trading on about 15 times.
That compares with the 17 times average since 1923, making the market fair value. The trouble is stocks overshoot. In the past 14 recessions, the average trough valuation has been 11 times.
The market's price/earnings multiple may be supported by falling interest rates (lowering investors' required return). However, since 1923, the market has, on average, bottomed just four months before the recovery in the economy.
Given that US gross domestic product for the third quarter grew just 0.8 per cent year on year and that the deleveraging process is only just beginning, it would be a brave soul who thinks the US is only eight weeks from the worst.
Price targets
As Fortis gurgled down the plughole a month ago, chief executive Herman Verwilst lamented, feebly, that most "recent analyst reports give price targets significantly higher than today's stock price". He had a point although not the intended one. Top-down valuations have their drawbacks.
Meanwhile, markets manipulated by spasmodic state interventions and distorted by the sin-binning of short sellers, have made a mockery of rigorous, bottom-up analysis too.
A note from Nomura last week admitted that aligning market movements with fundamentals "is virtually impossible". As investment banks re-examine their reasons for being, what future for their research departments?
The personal stock of equity analysts was downgraded long before this crisis. US analysts' success in predicting profits peaked in the fourth quarter of 2000, the year that new laws on equal access to price-sensitive information were adopted.
Accuracy levels have fallen for six of the seven years since, according to Bloomberg, reaching a record low in the second quarter this year.
Now, some analysts are trying to stay relevant by upping the frequency of recommendation changes. Exane BNP Paribas, for example, recently downgraded one UK bank barely a fortnight after an upgrade.
By the time markets return to an even keel, more analysts may have moved from the ivory tower of their publishing departments to sit alongside traders as so-called desk analysts, generating ideas on the fly.
Others may end up at smaller boutiques. UBS saw which way the wind was blowing in March, taking a minority stake in Integrity Research - a business advising the buy side on navigating the growing universe of independent providers. Banks shouldn't let go of research entirely.
A giant re-equitisation of markets awaits: the volume of new equity issuance has been running negative for the past four years, dwarfed by repurchases and leveraged buy-outs.
Still, a "buy" on the profession would be a brave call. The days when lunch with Henry Blodget was akin to a personal audience with the Pope are long gone.
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