Over the past five years, the FTSE 100 Index has delivered a return of more than 70%*. But the earnings of its constituent companies have actually fallen over that same period, languishing at zero or negative for each of the past five years. Now, in 2017, the tide looks set to turn via a return to positive growth, with consensus forecasting to a 17% rise over the next 12 months*. Earnings growth underpins market valuations, so this increase is significant.
Looking ahead to the rest of the year there are two key drivers of earnings growth to watch out for.
The currency contribution
First, there’s the currency factor. Since the referendum in June last year, sterling has fallen by 14% on a trade-weighted basis. With 70% of the FTSE 100’s earnings generated overseas, this effectively represents a 10% boost to earnings. As Theresa May’s minority government begins negotiations with the EU in coming weeks, the perceived success of these talks will be quickly reflected in currency markets, with implications for the relative performance of overseas earners versus domestic companies.
M&A activity matters
Second, there’s M&A activity. A cheap currency and cheap credit can make deals highly accretive to earnings per share, a kicker that is not currently factored into forecasts. We have seen plenty of evidence of this in the UK year to date, with a very active M&A market not restricted to any one particular sector. We expect this elevated level of activity to continue.
In our UK Equity Growth fund it’s important to consider what level of growth is already anticipated in share prices and look for positive surprises. Energy stocks are a prime example. Despite high expectations for earnings growth over the next 12 months due to recovering oil prices, earnings revisions have lagged the market. On the other hand, despite lower absolute growth expectations, financials continue to surprise on the upside with improving outlooks for future growth. Additional pockets of unanticipated growth are also coming through in cyclical sectors such as industrials, support services and travel & leisure.