Analysts think US earnings for the last quarter of 2007 will fall more than 20% compared with the same period a year earlier, according to Reuters Estimates. Just four months ago, they thought earnings would rise more than 10%. So far, the relentless profit shrinkage has been concentrated in the teetering financial sector. But if a US economic recession comes down, earnings declines in other sectors may follow.
A similar reality applies to global earnings for 2008. Analysts still expect global profit growth of 13% over 2007, according to Citigroup Inc. Yet, global earnings have, on average, fallen more than 30% when the US has experienced recessions.Anyone who isn’t a die hard believer in the decoupled model for the global economy and thinks the US is headed for recession should prepare for significantly lower earnings than are forecast.
That could further dent stock prices. The average decline in global stocks during US recessions since 1970 has been 36%, Citigroup says. Since last July’s highs, the Morgan Stanley Capital International World Index is off around 15%. It’s true that stocks don’t look anything like as expensive as they did at the start of the 2001 US recession. The world index’s trailing price-earnings multiple, for instance, looks reasonable at 15 times. But price-book values, somewhere near the middle of a 30-year range, look less comfortingly low. What’s more, world stocks tend to put in their worst performance during the first half of a US recession. If we’re already there and it lasts a year, which would be about average, the bottom for global markets could be months away.
Investors in the US recession camp face two quandaries. One is where to put their money in the meantime—cash, for instance, isn’t offering much return. The other is when to jump back in. The second half of a US recession is typically associated with rising global markets, according to Citigroup. Maybe one way to spot the bottom is to wait until analysts’ earnings estimates stop going down.