Talking points: corporate earnings
Buying equities based on hope - for example, the hope of a giant Fed intervention, which pushed up markets last week - is rarely a sound investment strategy.
Rather, common sense suggests we should buy stocks based on fundamentals - specifically, their price relative to their outlook for earnings and growth. In periods of weak economic growth and elevated prices, who in their right mind - the logic goes - would buy equities knowing that profit growth was falling?
The answer, apparently, is quite a few of us. According to the latest filings for companies that comprise the MSCI Asia ex Japan index, year-on-year earnings growth contracted by 15.3 per cent.
That shouldn't come as a surprise. The firms that make up this index have been reported slowing earnings as far back as the second quarter of 2010, with profit growth turning negative late in 2011.
Of the 91 per cent of the companies in the Asia-Pacific index that have reported quarterly earnings since July 1, fully two thirds came below analyst projections. Just 35 per cent surpassed expectations.
The extent to which analysts have been double-guessing themselves can also be seen by their now frequent change to earnings forecasts.
For example, at the beginning of 2012, analysts expected full-year earnings growth of almost 16 per cent for firms in the MSCI Asia ex-Japan index; by August, that forecast had been dialed back to 12 per cent; and by the year end, could measure as little as 6 per cent.
In fact, except for Thailand, Singapore and Philippines, every country comprising that index has seen its forecasts for full-year earnings growth revised downward.
To be fair, the expected earnings growth for the index firms of mid-single digits for 2012 is better than the minus 1 per cent recorded in 2011, so perhaps we should temper our disappointment. Moreover, analyst expectations for earnings growth for 2013 are meaningfully higher than current rates, suggesting markets could rise alongside profits. Could we get our fourth quarter rally?
If only. Analysts are habitual optimists. They commonly over-estimate earnings, and this year should be no different.
Weak export growth, decelerating domestic demand and lingering concerns over inflation are hurting economic growth across Asia in general and China in particular.
The uncertainty this causes saps business confidence, retards investment and cuts profits.
Profit weakness deters capital inflows - the lifeblood of Asian equities. The end result is an under-performing market, or exactly the kind of sluggish performance that has characterised local equities over the past three or four years. This is unlikely to change any time soon.
John Woods is chief investment strategist, Asia Pacific, for Citi Private Bank