By Ad van Tiggelen, senior investment specialist, ING Investment Management
Global equity markets have clearly not been profitless for investors this year, rising by 14% till September. With central banks massaging away any wrinkles the ride has also been unusually smooth. Looking at the low volatility one might even think that all is well in the world. However, corporate earnings off er a reality check. Their growth remains stuck at 3 to 4% this year and is not likely to be much higher in 2013. What does this imply for investors?
Corporate profit growth this year is gradually flattening, a phenomenon likely to be confirmed by the current (third quarter) earnings season. In Europe, earnings even show a slight decline, mainly due to Spain, the UK, France and Finland (Nokia). In the US, earnings are still expected to rise modestly this year, led by the ongoing recovery in the financial sector and by the superior performance of some of the technology bellwethers, especially Apple. For 2013, analysts project earnings to rise again by over 10%. However, few investors believe this number. And rightfully so, as financial analysts have a history of being too optimistic in eight of every 10 years. Given the fact that profit margins already hover around all time highs and that global economic growth in 2013 is expected to be not much different from this year, another low single digit earnings growth rate is much more feasible. In this environment one has to wonder to what extent equity markets can continue the, certainly in Europe, profitless recovery we have witnessed so far in 2012.
We think that the potential for markets to become more expensive – or less cheap – has not been exhausted yet, taking into account the following considerations: • The current price to earnings ratio of equities (14 in the US and 12 in the rest of the world) is in itself around average in a historic context, but is still attractive if compared to the ultra low yields in the fixed income market. • Corporate balance sheets are generally very healthy and offer room for more cheaply funded debt to finance M&A and share buy backs. • Central banks appear increasingly committed to ‘massaging’ the economy in such a way that the risks of systemic disruptions or deep recessions remain relatively limited, a fact which could keep equity volatility lower for longer. This does not mean that equity prices, which come from a bombed out base in 2009, can keep rising at a faster pace than earnings for a prolonged period.
After all, the low bond yields which currently support the valuation of equities will rise again when the economy recovers and/or when inflation has clearly bottomed. Alternatively, when yields remain depressed this will probably reflect an economic climate which is not supportive of profit growth. One cannot have both low bond yields and decent profit growth for many years in a row. Having said this, most equity signals still fl ash green at the moment. In a world where the IMF wants to see more inflation in the strong economies and where at the same time central banks are intent on keeping rates near zero, a soundly financed corporate world deserves a very decent valuation, even if profit growth is limited.