10th April 2013
Equity prices cannot continue to diverge from earnings forever Schroder’s chief economist Keith Wade has warned in the firm’s latest Global Market Perspective.
Wade says that the global equity rally has seen a re-rating of the market through a price-earnings ratio increase rather than by an increase in earnings. He adds that firms will struggle to increase profits.
In a note, he writes: “As our analysis makes clear, despite signs of better GDP growth, firms will struggle to raise profits in an environment where margins are already very extended. When this becomes a worry for the market remains to be seen as equity prices can diverge from earnings for some time. However, not for ever! Over the medium term earnings and dividend growth are the key drivers of equity performance and with this in mind this edition of the Global Market Perspective includes our estimates for asset class returns over the next thirty years.”
The note continues: “ Looking ahead, we expect global equities to continue to perform underpinned by central bank liquidity and favourable valuations, especially when compared against US Treasuries, UK Gilts or German Bunds. However, we are tilted toward the safer more defensive US and UK markets. In part this reflects the better macro picture in the US where the economy has made considerably faster progress in de-leveraging in the private sector. European banks are some way behind their US counterparts, a factor which will weigh on the region’s economy.”
Wade points out that in the previous Global Market Perspective, the firm argued that “We see scope for equity markets to re-rate further in the first half of 2013, eventually investors will require a follow through into earnings growth.”
Wade adds: “At this stage there is little sign of any improvement in the latter. Although we have had the usual hoopla surrounding the recent earnings season, the fact is that earnings growth has stalled. For example, according to Standard & Poor’s, operating earnings on the S&P 500 came in at $32.2 per share in 2012 Q4, down from $24 in Q3 and 2.4 per cent lower than a year ago.
“This is not just a US phenomenon: Our breakdown of global equity market returns shows that the earnings element has been a negative for the past 6 months with the rally being entirely driven by a re-rating of the market.”