Chart Of The Week   May 19 2022

Growth And Earnings Estimates Are Diverging

EU and US divergence

Global growth headwinds have increased since the start of the year. Commodity prices have soared on the back of the war in Ukraine. The Eurozone’s near-term economic outlook has dimmed and is at risk of a more severe deterioration if Russia deprives it of its natural gas exports. Economic activity in China has slowed significantly and Beijing’s commitment to the zero-Covid policy will continue to weigh on the country’s economy this year – a negative development for global growth. Meanwhile, the Fed has shifted in a significantly more hawkish direction and will continue to tighten monetary policy in order to bring down inflation.

Economists have been consistently revising down their real GDP growth forecasts for the US and Eurozone since the beginning of this year to reflect the economic impact of these headwinds. However, analysts’ EPS estimates have been trending higher.

One plausible explanation for this dichotomy between growth and EPS estimates presented at Thursday’s BCA Live & Unfiltered meeting is that EPS forecasts were overly conservative at the start of the year. This would imply that current earnings estimates are now in line with the weaker growth outlook – and that EPS projections will therefore remain resilient. Notably, our Global Investment strategists recently upgraded their tactical recommendation for equities to overweight, in line with their cyclical view.

However, our US Equity strategists are less optimistic. In a report published back in March, they created an equity capitulation scorecard to assess whether the US equity market is pricing in economic and political developments. A downwards revision to earnings estimates is one of the prerequisites they included for a sustainable market rebound. Similarly, our European Investment strategists also highlighted that current 2022 European earnings estimates are too lofty and vulnerable to significant downwards revisions. These assessments warrant a cautious near-term stance towards Eurozone and US equities.