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Global Equity Strategist: Probability of a Corporate Profits Recession  

The 20, 20, 20 Rule — At their lows last week, global stock markets declined by about 20% from 2011 highs. In the past stock prices have taken one of two general paths from here. Either an extended bear market decline, where prices fall a further 20%. Or a rebound where stock indices gain 20% over the next 12 months.

Global Rebound — We believe a rebound in stock prices is the most likely outcome from here. Extended bear market declines occur almost exclusively around a corporate profits recession. These are periods when EPS falls by 10% or more. Our analysis suggests the probability of a global profits collapse is rising but still low.

Global Earnings Outlook — From here, to get an earnings collapse, we need to see a combination of (1) considerably higher RoEs, (2) faster capex growth, (3) more extreme stress in inter-bank markets and (4) wider credit spreads. We now forecast 9% global EPS growth for 2012. Bottom-up consensus expectations suggest +15% and look too high. But global equities imply -10% and look too low.

Gains Ahead — Our new index targets suggest stock markets will make solid gains over the next 18 months, as prices grind higher with EPS. We now forecast 360 for the MSCI ACWI for end-2011 and 390 for end-2012. The index is currently at 307.