Standard Life Investments predicts that this year will see a robust profits cycle despite event risks, policy tightening and regulatory headwinds which will periodically worry investors.
Notwithstanding a recent moderation in expectations for future earnings, analysis by the global fund manager of the key drivers suggests 2011 will see profits surprise on the upside, driven by a continuation of corporate pricing power and cost control.
In the latest edition of Global Perspective,Standard Life Investment argues that, from a macro viewpoint, global profits at this juncture of the cycle are more likely to be driven by a trade-off between headline sales growth and cost growth, rather than any one-off write-downs or extraneous factors. With investors’ sensitive to numerous event risks around the world, they will rely on the relative strength of the corporate sector to help convince them that assets that carry a risk premium, such as property, credit and equities, are worth holding in portfolios. At this stage of the recovery, profit growth always slows noticeably after the initial bounce. The question is whether it will slow more than the market currently expects.
Richard Batty, Global Investment Strategist, Standard Life Investments, said:
“While the Q1 2011 profits cycle has been robust, with outcomes ahead of initial expectations, investors are rightly worried about the outlook in view of policy headwinds such as tighter fiscal and monetary policy, plus a harsher regulatory environment. Indeed, expectations for profit growth have been moderating recently.
“The global profits cycle is at an important juncture; the growth rate has peaked but much of the profits recovery was driven by operational leverage, where companies cut costs, notably labour in 2008 and 2009, and then enjoyed a rapid margin expansion as sales recovered in 2009 and 2010. The subsequent huge leap in profits, albeit from a recession induced low base, has turned out to be the most robust on record, leading companies to take a record share of economic output.
“This will not be repeated again in this cycle, so the consensus only expects global profits growth of 16% in 2011. However, our macro-economic model of the profits outlook suggests profits could exceed the current consensus this year. Key assumptions are that sales, driven by decent pricing-power, are likely to be robust and cost control is likely to remain intact even in a number of macro scenarios.
“We have also analysed various scenarios. Our results indicate strict cost control can still drive profits even if the economic recovery moderates. Similarly, if cost control is applied while the economy gently accelerates from here, profits could surprise noticeably on the upside. One longer-term limitation though is the danger firms eventually hollow-out their business and erode their future growth potential. Another risk is the return to recessionary conditions where cost cutting is not quick or sufficient enough to off-set the revenue short fall.”
Source : Standard Life Investments Press Release
