Tom Winnifrith – PE Ratios and why I am bearish

I think equities will go up, but I am bearish. If that sounds like the sort of TA nonsense that my pal Zak Mir spouts I apologise. Let me explain. Equities will go up because the bond bubble is only starting to burst. We will likely continue to see steady outflows from bonds into equities at an institutional level and that will push shares commensurately higher given the sheer mass of capital that is parked in bonds at present. To be more precise, it will push blue chips and mid caps higher as those are the sort of liquid stocks institutions will buy. I am not sure that it will do much for the riff-raff tail on AIM however!

Out of the frying pan into the fire. Are equities good value? The FTSE 100 I propose to ignore as it is heavily weighted towards stocks that are always on low PEs (Banks) and those which are British companies in name only – all their earnings are overseas. Instead I wish to draw your attention to the FTSE 250 Index which, at 12763.64 trades, now on a trailing price earnings ratio of, wait for it, 18.66 times. Towards the top end of its long term levels.

Overwhelmingly, the companies within the FTSE 250 Index generate their earnings in the UK. I am not sure what the forward PE of the Index is, but I bet you that it is still in the high teens because the reality is that corporate earnings growth for UK companies is not going to be that great this year. The sector sell side analysts always over estimate earnings growth because their forecasts bear little assumptions to the macro-assumptions made by equity strategists and economists, and thus I rather discount what the forward PE of the FTSE 250 is anyway.

But the simple point is that those taking a macro view, suggest that the UK economy is unlikely to grow by more than 1% this year. In fact, I would be very surprised if it grew at all given that consumers are not spending; the Government is meant to be spending less ( but is not), European export markets are conked and businesses are too terrified to invest. My forecast is for UK economic growth of closer to 0% than 1% this year.

Now, given that backdrop and rising cost pressures in labour and raw materials with renewed sterling weakness (and in due course the headwind of rising interest rates) and that if firms were going to take out costs they would already have done so, then I cannot see how many firms out there are going to be able to increase margins this year. Many will struggle to just hold their margins.  And so, I just cannot see where the earnings growth needed to justify even a low teens PE let alone a high teens PE is going to come from.

Yet, folks seem to be in total denial. It is not as if the RNS statements issued by corporate UK en-bloc every day are that chirpy. There is the odd company that appears to be beating forecasts (Domino’s Pizza, Alliance Pharma are two of the stocks that I have tipped which have managed that). A good few say they are managing to meet expectations. But the number of “misses” is alarming. Throw in the odd bankruptcy (HMV) where investors face a 100% wipeout and I would suggest that the corporate earnings picture is – on balance – pretty uninspiring. Certainly across many sectors earnings visibility is poor. And that is driven by the macro backdrop which sell side sector analysts always opt to ignore.

The bottom line is that even if nearly all companies hit their earnings forecasts, earnings growth would probably not be dramatic enough to really justify the current market rating. But earnings forecasts will not be hit. And that is why I am so bearish while accepting that the flight from bonds may make we bears squirm for a while yet.

Tom Winnifrith is a keynote speaker at the UK-s top show for private investors and traders. With two more speakers announced today the line-up is all star and you can check it out plus book a free ticket at