With third-quarter reporting getting underway, the key difference this time is that growth expectations haven’t been simply pushed forward to the next quarter. Forecasts for the next two quarters and for all of 2012 have been downgraded amid increasing risk of recession.
While third-quarter earnings could meet these lowered forecasts, we believe fourth-quarter results could still disappoint.
Consensus expectations are for global sales and earnings growth over the third quarter of 1.5% and 4.6% respectively. All regions are expected to post modest growth, with the exception of Latin America and the UK. The strongest growth is seen coming from emerging markets in Asia and Europe, leaving these regions more vulnerable to disappointment.
In the US, earnings per share for the S&P 500 grew 8.3% in the first and second quarter of this year, and using the aggregate estimates for all of the index components, consensus estimates imply additional growth of 1.7% and 5.4%, respectively, over the third and fourth quarters. This would result in earnings growth of 16% for the full year, overly optimistic compared to our own estimate of 13.8%.
Looking at consensus views on sector performance helps shed light on the macroeconomic view. While there has been a general downgrade to third-quarter estimates for all sectors, with the exception of technology, the biggest cuts have been the areas that are most sensitive to the economic cycle such as basic materials and energy, and financials, which have been hit by concerns over exposure to the debt of potentially insolvent governments. In the fourth quarter, cyclical sectors such as consumer discretionary and energy are expected to recover, and financials are also expected to recover strongly.
Given our view that US economic growth will remain low through next year, a strong rebound in earnings for consumer discretionary stocks is unlikely. A Greek default, which we believe is inevitable though it continues to be dragged out, also implies potential for losses in the financial sector. Thus we believe estimates for 5.4% growth in fourth-quarter earnings are too optimistic. Slower growth of 2.9% would bring full-year earnings in line with our forecast for 13.8% growth, assuming that consensus estimates for 1.7% third-quarter growth are met.
The view that fourth-quarter and full-year 2011 consensus earnings forecasts are likely to be revised lower is backed-up by the historical correlation between the US purchasing managers’ index (PMI) and actual earnings.
With the US PMI close to 50, this correlation suggests delivered results are likely to be close to the consensus for the third quarter, but fourth-quarter forecasts remain too optimistic and downgrades are therefore likely to continue.
