By now, it seems clear that the US earnings season will be softer than was forecast a couple of months ago. In fact, there was more negative guidance during the second quarter than any time in this cycle and Morgan Stanley, like us, believes these soft results and weaker guidance are not fully discounted into a QE-hungry market. Lower oil, a stronger dollar (e.g. a one-standard deviation appreciation in the US Dollar against a basket of currencies decreases expected S&P 500 earnings by 2.6%), lower 10-year yields and a preponderance of evidence of lighter growth from economically sensitive companies are reasons for a lower view of Q2 EPS than we previously expected as UBS notes the 'official' US Q2 reporting season kicks off in earnest today with Alcoa followed by over 3,000 global companies reporting in the next two months. At the sector and stock level UBS sees particular risk around some of the higher rated areas such as consumer staples and consumer discretionary, where relative multiples are high and expectations are demanding and while they see consensus estimates for 2012 global EPS growth have been falling - at 9.7%, they remain too high given the Eurozone crisis / policy response; deteriorating global macro data; and the corporate profit cycle - and in that order of importance.
UBS - And Now For Something Completely Different
Global equity markets have had other things on their mind: Greek elections (two), Spanish bank re-capitalisation plans (many), EU emergency summits (c.20 since October 2009) and weaker macro data. We believe Global equity markets are currently being driven by three factors: 1) the Eurozone crisis / policy response, 2) deteriorating global macro data and, 3) the corporate profit cycle. And in that order of importance.
Nevertheless, this will be the first opportunity to hear direct from corporates about the impact of the broader macro slowdown on profitability. There will likely be a contrast with Q1. For example, in Europe the Q1 reporting season was actually the best for 4 quarters in terms of net beats. But that was at a time when European GDP growth was flat - our economists expect it contract -0.3% quarter on quarter in Q2. Additionally PMIs are averaging at lower levels in Q2 (chart 2).
Admittedly, consensus estimates for 2012 global EPS growth have been falling. But they still stand at 9.7% - a level we continue to believe is too high.
In particular, we remain concerned over margin risk as the profit cycle matures. In the vast bulk of the developed markets, margins are just coming off 30-year highs (although this is not the case in Asia).
At the sector and stock level we see particular risk around some of the higher rated areas such as consumer staples and consumer discretionary, where relative multiples are high and expectations are demanding. Disappointments in these areas will likely earn a sharper multiple de-rating along with any earnings downgrade. Globally, the top 5 sectors where current P/BV look most stretched relative to history are all consumer-based: tobacco, beverages, media, consumer services and retail.
We have tracked c.60 profit warnings from major companies across the globe. Unsurprisingly the most warnings have come in Europe. At a sector level, consumer discretionary, industrials and materials have provided the bulk of the warnings, with consumer staples having the most warnings of the defensives.
So, it will be intriguing to see what message we hear from companies over the next few weeks and there is clear risk for highly rated stocks that miss. But ultimately we suspect focus will switch back to the Euro zone, policy response and any indications from macro data as to whether a second half recovery is likely or not.
Peak weeks for Global companies reporting will be the second-half of July with over 1,200 companies reporting.
Most profit warnings have been concentrated in consumer discretionary, industrials and materials. In the defensives, the bulk of the warnings have come from the consumer staples.
Reasons given for profit warnings are sometimes hard to pin down – but we have divided the warnings so far into 5 general buckets below. As mentioned above, we continue to see the medium-term threat to earnings coming more from margins than top-line risks.