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Wealth Insights
March 2019
Will Earnings Downgrades Drag Markets Down?
As trade uncertainties and tighter financial conditions continue to drag on economic growth, downgrades to consensus earnings growth expectations are picking up speed across major regions.
History shows that EPS (earnings per share) downgrades are not fatal for markets. Since 1989, there have been 15 years when global equity prices have appreciated while consensus analyst EPS forecasts have been downgraded
In addition, earning downgrades are not unusual. In the current cycle, in every year except 2017 and 2018, we have seen analysts moderating EPS expectations at this time of the year.
Looking ahead, the three major factors that will drive markets in 1H2019 are the direction of U.S.-China relations, the Fed’s rate hike path, and the degree to which the global economy will slow.
On trade, positive reports from President Trump and the Chinese over the last month have provided the market some cause for optimism that an arrangement forestalling further tariff escalation can be reached. This is a conceivable outcome, in our view.
In terms of the global economic outlook, we expect a marked deceleration in 2019 but not a recession, particularly with the Fed on guard against downside risks, and inflationary pressures still relatively low. The surprisingly swift deterioration in economic and market fundamentals in 2018, however, serves up an important lesson for investors.
Fundamentals are becoming more transitory as we enter the late stages of the economic cycle, and investors need to be on high alert for fluid conditions ahead.
The tug-of-war between monetary normalization, slowing growth and gradually increasing inflationary pressures will continue to narrow the margin of error for central banks and policy makers.
This situation is exacerbated by widely-held expectations that the world is overdue for another downturn, as well as the reflexive dynamics between confidence levels, financial conditions and asset prices which tends to result in self-reinforcing cycles.
Higher volatility and risk premiums will also contribute to a more challenging environment and lower investment returns ahead.
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