By Philip Lawlor, managing director, head of Global Markets Research
Forward PE multiples have fully recovered from their March lows, with most now at or approaching their highest levels of the past five years. The bounce has been particularly striking for the US large-cap Russell 1000, which has climbed more than 600 basis points to around 20× (a 15-year high), and for the FTSE Europe, up more than 500 basis points. The Russell 1000 multiple retains its sizable premium to those of its developed peers, which have converged around 14-15×.
Regional 12-month forward price/earnings ratios (×)
Source: FTSE Russell / Refinitiv. Data as of May 15, 2020. Past performance is no guarantee to future results. Please see the end for important disclosures.
But, as the chart below illustrates, the global re-rating since the March nadir reflects the perverse combination of rising “Ps” and sharply falling forecasts for “E”.
Price/earnings decompositions
Source: FTSE Russell / Refinitiv. May 15, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
This tells us that markets are looking beyond today’s bleak pandemic-shattered economic landscape to the far brighter prospects on the post-lockdown horizon, reinforced by unprecedented central-bank and fiscal support. But have they gotten ahead of themselves?
As shown below, consensus FTSE All-World EPS forecasts for 2020 have been slashed back to 2017 levels of around $19, wiping out all of the US tax-cut-fueled gains since then and a stunning reversal from the strong growth projected for most markets only three months ago. At the same time, however, analysts have raised their estimates for 2021, which now anticipate even more robust recoveries across global markets than envisioned earlier.
FTSE All-World Index consensus EPS estimate trails (USD)
Source: FTSE Russell / Refinitiv. May 15, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
But there are reasons for caution. Forecasts for 2021 largely reflect base effects, as well as the tendency of analyst forecasts to initially overshoot, as the pattern of EPS trails in most years attests. And, with a record number of firms suspending guidance and hard data still scarce, earnings visibility remains unprecedently low.
Negative operating-leverage risks persist
As the chart below shows, there is the tight historical relationship between shifts in revenues and margins (operating leverage) and EPS growth prospects. With the economic ravages of the Great Lockdown already rivaling the worst experienced since the 1930s and the timing and pace of recovery still highly uncertain, negative operating-leverage risks remain elevated.
Russell 1000 revenue growth, net margins and 12-month forward EPS growth
Source: FTSE Russell / Refinitiv. May 15, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
As this implies, though the worst may be behind us, it’s still too early to sound the “all clear” on the negative earnings cycle.
Photo Credit: 401(k) 2012 via Flickr Creative Commons
DISCLOSURE
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