Earnings estimates still too optimistic

Consensus estimates for companies around the world are still too optimistic and shouldn't be relied upon when making investment decisions, according to JP Morgan Asset Management.

Globally, earnings per share (EPS) is expected to show a 14% decline for 2008 and a further 2.3% drop in 2009, according to the fund house. For the US, the consensus estimate is -13.1% for 2008 and -1.6% for 2009. For Asia ex-Japan, it is -18.6% and -4.5%, respectively.

"We still have a long way to go in terms of analysts cutting their estimates," says Geoffrey Lewis, the firm's head of investment services. "Analysts tend to follow rather than lead movements in the market."

Grace Tam, an investment services manager at JP Morgan Asset Management, says price-to-book ratios are a better determinant for corporate valuations, given that it has become very difficult to effectively pinpoint potential sources of earnings.

"Now is not the time to look at P/E (price/earnings) ratios or EPS. The numbers are too volatile," she says.

Within Asia, EPS projections for Taiwan, Hong Kong and Korea are the worst at -45%, -33%, and -25.7%, respectively, for 2008; and -44.9%, -12%, and +10.1%, respectively, for 2009. If JP Morgan's executives are right and these earnings estimates still have a way to come down, then the outlook for equities could be bleaker.

JP Morgan Asset Management is overweight only in two markets in Asia: China and Singapore, with the latter only very recently upgraded from a neutral. The stimulus packages of both countries have a lot to do with the fund house's relatively more bullish outlook for those markets.

Sentiment for China has been benefiting greatly from the Rmb4 trillion ($586 billion) stimulus package announced in November, which is aimed at combating the most serious economic threat to the mainland since the Asian financial crisis in 1997. Before the stimulus package was announced, China was riddled with worries over the impact of the global financial crisis on both domestic consumption and exports.

The stimulus package, with a life span that extends until 2010, covers key areas including  affordable housing, rural infrastructure, railways, power grids, post-earthquake rebuilding in Sichuan, and social welfare to raise incomes. It also includes reforming the value-added-tax system to encourage investment in new technologies.

With foreign reserves and a budget surplus amounting to around $2 trillion, investors are confident that China has the capacity to further stimulate the economy if needed.

"China probably won't save the world, but it has the determination and financial ability to save itself," says Tam. "This will benefit the rest of Asia."

Singapore announced last month a S$20.5 billion ($13.7 billion) stimulus package to help companies and save jobs, along with a one percentage-point cut in corporate tax. The package, which comes on top of regular government spending, includes S$5.1 billion on training and other measures to save jobs and S$5.8 billion to stimulate bank lending.

The stimulus package serves as a safety net for Singapore, which is entering its worst post-war recession, with expectations of a 5% economic contraction this year.

Investors welcomed the stimulus package, which is uncharacteristic for Singapore considering that the city-state tends to prefer to keep budget deficits in check. Singapore is expected to have a budget deficit of S$8.7 billion in the current fiscal year ending March 2010, which would amount to around 6% of gross domestic product, and will be financed for the first time by tapping into the government's estimated $300 billion reserves.

Elsewhere in Asia, JP Morgan Asset Management is underweight in Japan, Taiwan, Malaysia, and the Philippines. The fund house is neutral in other markets in the region.

The fund house is sticking with highly defensive sectors and avoiding cyclical sectors such as materials and industrials.