Stocktake

Earnings forecasts: The US earnings season is shaping up like recent quarters thus far, although next year's estimates continue to be cut. Estimates have been lowered in 10 of the past 11 weeks, with 2012 SP 500 estimates standing at $108.90.

The V-shaped earnings recovery is “losing steam”, notes US strategist Ed Yardeni. Estimates for 2012 remain 11 per cent higher than 2011 estimates, although Yardeni reckons that 2012 estimates will soon fall to $100.

If the US does fall into recession, however, history suggests the earnings hit will be much more severe. Morgan Stanley data shows that the last five US recessions (2008, 2001, 1990, 1981, 1973) have resulted in European earnings falling by an average of 40 per cent. Bianco Research data, meanwhile, show that US earnings forecasts were too optimistic by 25 per cent in 1990, by 23 per cent in 2001 and by 40 per cent in 2008-2009.

“In other words, if the economy goes into recession, the earnings forecasts are horribly wrong,” warns Jim Bianco.

Dividend payouts:Dividends are a different matter, falling by an average of just 11 per cent in the last five recessions compared to the aforementioned 40 per cent earnings fall, Morgan Stanley says.

The firm is bullish on European dividend stocks for other reasons. The payout ratio (the percentage of earnings paid to shareholders in dividends) is currently 45 per cent. That’s below its historical average and the payout ratio has increased to between 60 and 75 per cent during the last five recessions.

Just 21 per cent of European dividends come from financials, down from 40 per cent in 2007, whereas the most defensive sectors (consumer staples, health care, telecoms and utilities) contribute over 40 per cent.

In the UK, dividends rose by 16 per cent in the third quarter compared to 12 months ago, according to Capita Registrars. It expects the FTSE 100 to yield 3.8 per cent this year.

Volatile markets:Markets have been volatile for months now but it's not unprecedented, whatever some excited commentators might say. Laszlo Birinyi notes the SP 500 has moved by at least 1 per cent for 61 days in a row. That's volatile, although there have been four other periods since 1995 which have seen similar moves.

Quantitative portfolio manager and author Irene Aldridge broadly agrees, saying present intraday volatility levels are comparable to the late 1990s, early 1970s and 1962. Perhaps more importantly, high volatility “takes time to die down”, with “clusters of high volatility” being cyclical and lasting for for about four to six years.

Markets were slow and steady between 2004 and 2007 before volatility returned with a vengeance in 2008. History suggests it “may extend even through 2012”, says Aldridge.