IMF says current US equities vulnerable to correction on poor earnings
afxpress.com
WASHINGTON (AFX) - US equity markets are currently pricing in a sharp rebound in corporate profits that is out of line with consensus expectations, leaving the market vulnerable to a correction, the IMF said.
The markets "assume a sharp rebound (but) if that was not forthcoming ... that could result, could potentially result, in a backdrop in equity markets," said Gerd Haeusler, Director of the IMF capital markets department, in a press briefing.
The briefing was to unveil a new quarterly IMF publication on "global financial stability," which highlights risks faced in developed and emerging financial markets.
Hugh Tran, deputy director of the department, said with the S&P 500 index having a price-to-earnings ratio of around 22, the markets are assuming a 20-30 pct surge in US corporate profits in the next two quarters.
This is after a drop in profits as a share of GDP from 10 pct in 1998 to 7.0 pct last year, and runs against the consensus forecast of another negative quarter for earnings in the first quarter, and only a single-digit rise next quarter, he said.
Studying the historical record for equity markets anticipating economic and profit rebounds, the IMF report said US "industrial production and earnings need to turn around this quarter."
"If this turnaround does not materialise, there is a risk of a market correction," the IMF said in the report.
"The equity market has already had one false start in April-May 2001, in predicting an economic recovery," the IMF warned.
If earnings do not validate these market expectations, "the likely adjustment in asset prices and deterioration in credit quality could erode the still fragile business and consumer confidence," the report said.
This is particularly a risk at a time of record high household and corporate debt levels in the US, Japan, and Europe, Haeusler said.
"The ability of households to underpin economic growth" in OECD countries should be closely monitored, given these high debt levels and high debt-interest servicing costs, he added.
Turning to Japan, the IMF said that while prolonged economic weakness and deflation has seriously weakened many banks, this is not likely to have large knock-on effects for the rest of the world.
"The potential for stress in Japan's financial system to give rise to international spillovers may have declined," the report said.
The international loan portfolios of Japanese banks have contracted every year since 1996, the IMF noted. However, it cautioned that the potential for Japanese investors to repatriate large overseas investment holdings could affect global capital markets.
"The good news ... is that the interaction between Japanese financial system and the rest of the international financial system has become much less important over the last two years," Haeusler said.
The exposure of non-Japanese banks to loans in Japan has also decreased substantially in recent years.
From a medium-term perspective, however, a withdrawal of overseas bank lending by the world's second largest economy is not a positive development, especially to emerging market countries in Asia, Haeusler also said.
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