The earnings season has only just begun, but we are already seeing some examples of what will become a trend: fewer companies beating expectations.
Investors like to be positively surprised, so companies tend to be overly cautious in their expectations so as not to disappoint those same investors. But when the economy is heading for recession, expectations are met less often and this earnings season is probably the first indication of this.
So far, less than 70 percent of companies that have presented earnings have beaten expectations. Reported sales have exceeded expectations in just over half of the cases. Both numbers are considerably lower than in the previous quarter.
Overly enthusiastic
Throughout any major growth slowdown or recession, companies’ profits and sales have declined. And even if inflation can artificially boost nominal profits for a while, I do not think this recession will be any different.
However, that is not what markets think. Judging by current and expected price-to-earnings ratios, investors are implicitly counting on 15 percent earnings growth for US equities. For the world as a whole, it is less but still positive. So investors are still positive about expected earnings growth.
But the chance of 15 percent more earnings seems extremely small. Indeed, several indicators point in exactly the opposite direction. Korean exports, traditionally a good predictor of global growth and earnings development, point to a 15 percent drop in profits. That is quite a gap.
Emerging markets are the exception here. Markets are looking at a 6 percent fall in earnings per share. So for emerging markets, the bar is seemingly a lot lower. But with the surge in both commodity prices and the US dollar - both of which have a significant impact on the earnings of companies in emerging markets - even if you assume a global recession, a 6 percent contraction is on the low side.
Earnings are the next domino to fall, limiting the upside potential of equities.
Jeroen Blokland is founder of True Insights, a platform that provides independent research to build diversified multi-asset portfolios. Blokland was most recently head of multi-assets at Robeco. His “chart of the week” appears every Thursday on Investment Officer.
This article originally appeared on InvestmentOfficer.nl.