SocGen: No Rush To Implement An Earnings Recovery Strategy

The equity strategy team at Societe Generale concludes in a research piece:

Dealing with market efficiency. Markets are supposedly efficient, integrating a mix of all available information and forecasts at any given time.

Average advance of 9 months. Our analysis shows that equity indices are ahead of the earnings cycle by an average of nine months. The spread is wide, however, ranging from 14 months in advance for the 1990-91 recession to a surprising 10 months behind for the 2001/02 recession, bearing in mind that the latter was skewed by geopolitical events (9/11 and the Iraq-US war), which further weighed on equity indices.

Implement a beta-driven strategy when the turnaround begins. We have backtested a strategy based on a beta-driven approach when equity indices turn around. The strategy delivers positive returns over the last market trough or high: with a long/short approach (with baskets of high- or low-beta assets), the performance delivery ranges from +1% during the 2003-2007 bull market to +79% during the 2000-2003 bear market.

Do not raise your portfolio beta before spring 2009. Overall, if we expect the economy to turn around by the end of the year and geopolitical risks and corporate defaults to be at the forefront of the newsflow, we are not tempted to buy into an early recovery. As highlighted in our latest Multi-Asset Portfolio report, while we consider equities to be cheap, we would wait for the current earnings season to end as we see further significant downgrades ahead and would revisit our equity stance by spring 2009.

Markets start to move nine months earlier than the economy on average, but the reactivity spread is high.

Well, do not overestimate the predictive power of equity markets. What they were pricing in from the August till November of 2007?