Seemingly everyone, on both sides of the Atlantic, is now taking about recession. Even Mervyn King.
So why, asks SocGen’s James Montier in his latest issue of Mind Matters, is the investment research industry still predicting earnings growth of between 12 and 15 per cent?
He’s got a chart to illustrate that analysts are exceptionally good at one thing and one thing alone - telling you what has just happened.
Aside from the bullish bias built in to the investment industry and the obvious challenges of foretelling the future, Montier blames this on the all too cozy relationship between analysts and corporate management.
Memo to analysts: management havent got a clue. They dont know any better than the rest of us. One of the great delusions of our industry is that we all expect corporate managers to know more than we do. Whilst their knowledge may be deeper than ours, it certainly doesnt translate into a better ability to forecast the future…
It is this optimism that is being drip-fed to analysts, who, seemingly incapable of any form of independent thought, are happy to regurgitate managements mindless drivel to investors. This raises yet more questions as to why it is that we all employ so many analysts, if their major function is just to be a quasi-IR department for corporates.
Indeed!
To get around this forecasting problem, Montier simply takes the current forward price earnings multiple and then compares it with the average forward P/E over history. This, he claims, provides a rough calculation of the expected decline in earnings.
It throws up an implied 20 per cent decline in US earnings and a 34 per cent drop in Europe - similar to the falls seen during the last two recessions.
But that’s far too upbeat for a man who sits in the same office as the permabear, Albert Edwards.
Since these numbers are all based on analyst forecasts, they refer to operating earnings. Unfortunately the history of operating earnings is short (only starting in the mid 1980s). Thus it only encompasses two exceedingly shallow recessions…
This time around it could be a much more prolonged and deeper affair as the bursting of a credit bubble forces the US consumer to retrench for the first time in a quarter of a century. If such an eventuality comes to pass then these implicit declines in earnings are unlikely to provide a sufficient margin of safety.
