The Big Chill
􀀗 Freezing profits will keep volatility high for a while yet
􀀗 Non-financial earnings are now falling quickly
􀀗 Depression-type falls are possible – without the Depression

Our global cyclical indicator rose in January for the first time since August, but only a little and
from a very low base. Inventories – think cars – pose a big threat in H1, and the hugely
important US economy may shrink as quickly in Q1 as it did in Q4. Against this backdrop, we
take a quick look at the results season to date, and at some of the earnings risks in 2009.
We estimate that the blended total of reported and estimated US results for Q4 stands at -40%.
Financials are still faring worst, but non-financial earnings are now down 19% also.
How much further could earnings fall? A long way, is the short answer. Our own top-down
estimates for 2009 have been relatively low, but the outturn could easily turn out worse. The
bulk of the decline in earnings to date has come from financials, which leaves the non-financial
sector’s downturn still to come.
We suggest plausible orders of magnitude for several macro risks, including a substantial
inventory write-down. Combined with a sprinkling of “typical” company-specific shockers,
total earnings could easily fall by as much as 70% from their peak – a near-Depression
outcome, but without the Depression itself.
We do not expect these risks to materialise, and are encouraged at the market’s resilience
during the results season to date: we still see markets rallying during 2009. But investors’
awareness of them will help keep volatility high for a while yet.

US reporting season update
At the mid-point in the US Q4 results season the
main message is that the corporate earnings
newsflow continues to be dire (refer to the table
on the following page for the results).
Our analysis shows that through Tuesday, 3
February, 255 S&P 500 companies had reported
their Q4 results (equal to 69% of market cap). Our
estimate of the blended growth rate – made up of
actual results for the companies that have reported
and estimates for those that haven’t – is -40%. By
excluding Financials the fall is limited to 19%, but
this is still pretty poor.
Of the ten GICs sectors, we find only three with a
positive growth rate: Health Care (+9%), Utilities
(+2%) and Consumer Staples (+2%).
In terms of the major drags on the broader market
earnings, Financials with a growth rate of -674%
cause the bulk of the damage with Consumer
Discretionary (-76%) having the second biggest
negative impact.
The Financials sector has swung from a small
profit of USD5bn a year ago to an (estimated)
huge loss of USD30bn. This equates to a negative
contribution of USD35bn (or 21 percentage
points) to the aggregate earnings growth estimate.
Furthermore, from the table we can see that most
Financials are still missing forecasts – of the 47
that have reported, 74% have reported earnings
below expectations.
As for Consumer discretionary, this is really an
Autos story given that it accounts for USD8bn of
the USD11bn negative sector contribution to the
aggregate earnings growth estimate. Note that
elsewhere in the Consumer Discretionary sector
we find the Consumer Durables & Apparel
industry is actually making a positive
contribution, not because it is forecast to make a
profit but because the loss is expected to be lower
than the comparable quarter a year ago.
For the market ex-Financials we find that the
results have not been too bad relative to analysts’
expectations with 64% of companies beating and
27% missing – on average 60% beat and 20%
miss.
Nevertheless, this is only a small crumb of
comfort in what can only be described as a pretty
awful reporting season. As a reminder we have
been expecting earnings (and economic)
disappointments to act as a strong headwind for
the market as we moved into the season.
What is perhaps most interesting, though, has
been the general resilience of most key indices
during the period, in particular if we exclude the
noise created by the ongoing financial crises. And
there do appear to have been some tentative signs
that the market is starting to roll with the
economic/earnings punches over the last few
months.
This may indicate that the economic and
associated earnings gloom is to a large degree in
the price and that the market is looking forward to
at least a slowdown in the rate of decline as we
move through 2009.
The strong tailwinds resulting from the huge
monetary and fiscal stimulus packages already
announced, a sharply lower oil price and policy
interest rates falling to close to zero in many of
the key regions may all help to support stock
prices as we move into Q2…