Citi global strategist Robert Buckland thinks equities are priced for a mild slowdown but also believes a profit recession is underway that could take global equities lower by another 20 to 30 per cent from current levels.
Using 15-year historical averages for valuations, Mr. Buckland estimates that stocks are currently priced for a 5 to 10 per cent earnings contraction. However, the strategist notes that profits fell by 31 per cent on average over the past seven earnings recessions. A reoccurrence now would see the MSCI World Index fall by up to 30 per cent.
Global profit margins factor into Citi’s pessimism. Mr. Buckland noted that the average return on equity (ROE, a common measure of profitability) for global stocks, at 16 per cent, is at a level last seen just before the financial crisis. A fall in ROE to the long-term average of 12 per cent implies a 25 per cent decline in global profits.
The strategist notes that analysts are already reducing earnings assumptions for commodity sectors in preparation for a mild deterioration in profit growth. “In every other cyclical sector, [earnings per share] are expected to grow,” writes Mr. Buckland in a research note. “An outcome anywhere near the average of past recessions suggests that forecasts in these sectors are still much too high.”
For now, the U.S. bank is keeping to its view that there will be a mild 5 to 10 per cent earnings recession in 2023. Mr. Buckland, however, makes it clear that the risks are to the downside. Investors should be aware of the growing potential for an earnings slowdown, and limit portfolio exposure to economically sensitive equity sectors if volatility climbs.
-- Scott Barlow, Globe and Mail market strategist
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