The financial information firm Factset came up with an eye-opening chart showing that bottom-up estimates of S&P earnings track the price of oil:
There are two kinds of information in this chart. The first is the extent to which overall S&P earnings depend on the energy sector. The second, which Asia Unhedged thinks is more important, is how lazy equity analysts are. The energy analysts simply made a straight-line projection of energy sector earnings on the basis of the oil price, and the bottom-up estimates simply factored energy sector estimates into the overall estimates.
And for this, equity analysts make a living? To be fair, the correlation noted by Factset is in some respects spurious. Oil is highly correlated to the dollar, and the rising dollar also reduces corporate earnings (and equity analysts know how to make this calculation). So what we observe in the Factset chart is not just the impact of oil prices, but the combined effect of oil and the dollar.
Very little thought (and even less intelligent thought) has gone into the knock-on effects of a lower oil price: what does it it mean for capital goods industries, for example? Most macro forecasters assumed that cheaper oil would spur consumer spending, and were beguiled by outsized employment growth numbers in January and February that just were revised downward by 69,000 jobs.
Then there’s the disturbing discrepancy between GDP profits adjusted for capital consumption allowance and reported per-share S&P earnings, which Asia Unhedged discussed earlier this week.
All in all, bottom-up forecasts suffer from the same kind of Cargo Cult optimism that skewed the macro forecasts. Q1 profits are likely to be riddled with disappointment. U.S. equity investors, beware.
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