Investment Research Group
|
When earnings come in under forecasts, it is not uncommon for a slide in share prices as disappointed investors sell. When markets are as volatile as they are now, investors become very unforgiving about nasty surprises. The problem is that at the end of a bull market, many young analysts tend to be far too optimistic about their forecasts because they have only experienced good times.
Yet these earnings projections are vital to the exercise of selecting shares you would want to invest in. Like all exercises that require data, your conclusions become unreliable if the input is unreliable.
That we are being presented with estimates that are no longer believable was illustrated in a recent ING Investment report. In it, Brian Gendreau, Investment Strategist points out that at the beginning of the fourth quarter 2007, US equity analysts were too optimistic.
"The consensus was that earnings of the S&P 500 Index companies would grow by over 10% from a year earlier. But week after week as the quarter wore on, analysts marked down their estimates and the stock market followed the revisions downward.
“By the second week of February 2008, with most companies reporting, it was clear that earnings had actually dropped by over 22% in fourth quarter, a whopping 32% below the original estimated growth rate.”
For 2007 as a whole, it now appears that earnings declined by 1.9%, the first annual decline since the recession year of 2001, point out Gendreau. “These figures paint a pretty dismal picture. But no worries, equity analysts say earnings will rebound in 2008, according to Reuters, growing by an estimated 15.4%.”
I have a problem with comments that imply a recovery is just around the corner. It follows the thinking that there must be a quick fix for everything. But the problems we face are slow burning and long-lasting.
This week Britain decided to nationalise Northern Rock following a five-month attempt to find a private sector buyer for the ailing bank. Britain's fifth-largest mortgage lender has borrowed 25bn pounds from the Bank of England since its collapse in the credit crisis last year, sparking a run on the bank.
There are good reasons why Governments step in when a major bank is on the verge of collapse. If a major bank is allowed to go under it can create an unstoppable domino affect resulting in a meltdown in the financial system.
The reason is that banks create money and even the best of them cannot pay out everyone that lands on their doorstep at the same time on the same day. The problem is that the British Government’s attempt at shoring up confidence could be futile if more banks fall over as a result of the unfolding US debt crisis.
It cannot save all of them all. One UK economist remarked that in a credit fallout such as we are now seeing, “you don’t know where the bodies are buried.” We have no idea who has exposure to what, so complicated and intertwined has the world of finance become. And judging from the past, things could get a lot worse before they get better.
