Thursday, June 4, 2009


V-shaped recovery?
  • Consensus earnings revisions ratios for all main regions are showing a V-shaped profile, as are some economic indicators
  • Improvement has been so dramatic that earnings upgrades are now almost matching downgrades for the world index
  • Normalising rates: combination of stabilising profitability and favourable valuations should allow equities to live with the normalisation of long-term interest rates, in our view
Very few commentators appear to be giving serious consideration to the likelihood of a ‘V’-shaped global economic recovery (which may make you wonder where the balance of risk lies from here). The most popular representative letters still appear to be ‘W’, ‘U’ and ‘L’. But, if the profile of analysts’ earnings revisions is any guide, the possibility of a decent rebound in economic growth and corporate earnings should not be ruled out.

The normalisation of interest rates has been beginning to feature in our discussions with investors, spurred by the sell-off in government bonds. As we write, the sheer steepness of the yield curve seems to have capped the surge in long-term yields, for a while at least. And recent levels of yields are not yet hitting equity valuations materially: the implied risk premium remains well above trend. But, at some stage, equity markets will have to tackle this question more definitively.

In our view, a combination of stabilising profitability – which may be a little closer perhaps than we’d thought – and favourable (cyclically adjusted) valuations, together with a conscious decision by asset allocators eventually to dump bonds and money-market mutual funds for stocks, should allow equities to live with the normalisation of long and even short-term interest rates when this finally happens for real.

To see full report: EQUITY INSIGHT