Earnings may be about to do something they've never done before

Key Points

  • The earnings estimates for the world's companies have risen back to $30 again for the fourth time in 10 years.
  • Without a rise in earnings above $30, stock prices may find it difficult to move any higher.
  • Thanks to solid global growth supporting all the major regions of the world a break out above $30 now appears more likely than it has in a decade.

Ever get the feeling that we've been here before? For investors, the sense of déjà vu may be coming from corporate earnings. The analyst consensus estimate for earnings per share over the next twelve months for the world's companies (measured by the MSCI All Country World Index) has risen back to $30 again for the fourth time in 10 years, as you can see in the chart below.

Earnings déjà vu

Earnings déjà vu

Source: Charles Schwab, Factset data as of 8/17/2017.

Since first reaching this level in 2008, earnings per share for the world's companies has taken about three years to return to $30 after each decline. Despite the similar three year intervals, each decline in earnings was unique with differing depths and drivers.

  • The drop after the 2008 peak, due to the global financial crisis, was deep and broad across regions and sectors.
  • The drop after the 2011 peak was shallow and tied to the relatively mild recessions in Europe and Japan.
  • The drop following the 2014 peak was greater than 10%, but almost entirely due to the impact of the crash in oil prices on the Energy sector.

Interestingly, the regions that lifted earnings to $30 have also been different each time, as you can see in the chart below (all regions' earnings per share are indexed to 100 at the start of 2004 to make the comparisons easier).

  1. In 2008 it was Europe and the emerging markets that contributed the most to lifting global earnings to $30.
  2. In 2011, the full rebound in the United States and emerging markets were the drivers back to $30.
  3. In 2014, Japan's rebound to its prior peak offset weakening emerging markets to reach $30 again.
  4. In 2017, the current rebound to $30 was supported by a rise in all regions.

Stark regional divergences in the pattern of earnings growth finally converging?

Stark regional divergences in the pattern of earnings growth finally converging?

*Analysts' consensus estimate for earnings per share over next twelve months.
Source: Charles Schwab, Factset data as of 8/17/2017.

The good news is that earnings may finally be able to remain above $30 over the course of the coming year. The strongest and broadest global economic growth in years supports a lift in earnings above $30 for the first time ever. All of the world's top 20 economies are growing in 2017, marking the first year this has happened since 2010. The International Monetary Fund forecasts global growth to continue to accelerate in 2018, according to their World Economic Outlook released in July.

The two regions that have yet to recover their past peaks look set to make further progress:

  • Emerging markets, often dependent upon the pace of global growth to drive their exports, are benefitting from a rise in world nominal GDP to the highest level since 2011. Risks to emerging market earnings growth include a sharp rebound in the dollar and/or drop in commodity prices.
  • Europe has seen surprisingly strong growth this year, overcoming political worries at the start of the year. Europe emerged from recession in 2013 and is earlier in its business cycle than the United States which emerged from recession in 2009. In fact, it was only two years ago that GDP in the Eurozone recovered to the prior peak seen in 2008. Profit margins in the U.S. have already rebounded to their 2008 level, in Europe profit margins may have more room to rise as the business cycle lengthens, as you can see in the chart below. Risks to Europe’s earnings growth include lingering banking sector and debt problems.

Profit margins may have more room to rise for European companies

Profit margins may have more room to rise for European companies

Source: Charles Schwab, Factset data as of 8/21/2017.

Relative to the prior periods when earnings hit $30, valuations are now much higher. For the world's stock market to rise materially and sustainably, it is our view that earnings must push through $30. The most commonly used valuation measure, the price-to-earnings ratio, for the world's stock market is close to a 15 year high. Without a rise in earnings above $30, stock prices may find it difficult to move any higher. Fortunately, that now appears more likely than it has in a decade.

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