Monday, May 4, 2009

Do earnings lag price bottoms?

There’s been a fair amount of commentary on the ‘low’ earnings numbers for 2009. It’s generally assumed that the severe earnings decline expected in 2009 cannot possibly be good news for the equity markets. Here’s how the earnings have been trending (data courtesy

Came across a new piece of information, courtesy FT Alphaville. While earnings and price trends are definitely coincident, the two needn’t trough at the same time. Here’s a chart, where the earnings essentially decouple from the prices.The first is a theoretical illustration of the phenomenon and the second and third, smaller charts, are of the previous earnings recessions in the early 1990s and early 2000s.

The article goes on:

The 25% market rebound that started in early March has not coincided with the bottom of the earnings cycle. Since then, forward earnings expectations have continued their downward trajectory. The twilight zone is the period during an earnings cycle where stock prices begin to stabilise but profits continue to fall.

2009 is shaping up to look more like a twilight zone. Earnings are falling faster than share prices, the market is re-rating, cyclicals are re-rating aggressively and earnings momentum strategies are struggling — all signs of twilight zones. Are we saying that the next bull market has started? No but we are saying that markets have stabilised and are unlikely to fall beyond the March 2009 lows.

Declining earnings estimate numbers don’t necessarily imply lower equity valuations and price declines. The earnings decline might already be priced in.