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The consensus and reality on earnings

Contrary to the pre-crisis period when they were underestimated modestly, earnings have been systematically overestimated in the post-crisis period. This is true for DM, but especially so for EM, for which forward earnings expectations have overestimated subsequently realised 12m earnings growth by 12.5pp on average (Figure 89). There is a high likelihood that this pattern repeats in 2019. Our own estimate is about 4pp below consensus. We think consensus forecasts remain elevated as our EM Cycle Index for six-month revisions in 12-month forward EPS is declining to levels consistent with further downgrades (Figure 90).

EM and DM have both consistently missed earnings growth forecasts, but EM more so

Figure 89: Gap between forward and trailing earnings growth for MSCI EM

Figure 90: EM Cycle Index vs 6m revisions in 12m forward earnings

							6
50pp							4		Correlation: +0.92
30pp							2
							0
10pp						Average = 12.5	-2
							-4
-10pp							-6
	Average = -4.3						-8
-30pp							-10
-50pp							-12
							-14
03	04 05 06 07 08	09	10	11	12	13 14 15 16 17
	Gap between 12m fwd and 12m trailing earnings growth for EM						Jan-11	Jan-12	Jan-13 Jan-14 Jan-15	Jan-16	Jan-17	Jan-18
	Average (pre-2011)								6m revisions in 12m fwd EPS
	Average (post-2011)								EM Cycle Index for 6m revision in 12m fwd EPS (RHS)

2.0

1.5

1.0

0.5

0.0

-0.5

-1.0

-1.5

Source: IBES, MSCI, Datastream, UBS

Source: Bloomberg, Haver, IBES, MSCI, Datastream, UBS

We estimate MSCI EM earnings growth on the basis of four variables (Figure 91):

UBS Tech Index – first principal component derived from the following three metrics: i) y/y growth in global semiconductor sales; ii) Japan memory chips sales to inventory (3mma); and iii) Japan semiconductor devices sales to inventory (3mma).

12m EM credit impulse (bp) – 12-month acceleration in EM credit, i.e. 12month change in EM credit growth rate.

y/y change in commodity price index (%) – 40%/60%-weighted average of industrial metals and oil.

EM Cycle Index – the level of our proprietary index, which includes 10 subindices that lead the EM growth cycle.

Our base-case scenario presented in Figure 91 implies 6.4% EPS growth for MSCI EM in 2019 against a consensus estimate of 10.6%. We also present an upside and downside scenario for earnings. The wide range of forecasts these encompass is a result of the very high variance in the historical distribution of EM earnings growth series (Figure 92).

Our earnings model points to growth of 6–7% next year

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Figure 91: MSCI EM EPS growth: Base-case, upside and downside scenarios

Figure 92: Actual, fitted and residual of our EPS growth model

2018E

2019E

			Downside	Base Case	Upside
	UBS Tech Index	0.77	-0.25	0.25	0.8
	12m EM credit impulse (bp)	-7.3	-50	30	50
	y/y change in commodity	10.8	-20	0	20
	price index (%)
	EM Cycle Index	-0.7	-3.0	-1.0	1.0
	EPS growth (%)	9.7	-6.5	6.4	16.5
	Source: Bloomberg, Haver, IBES, MSCI, Datastream, UBS

27		20
		15
17		10
7		5
		0
-3		-5
-13		-10
		-15
-23		-20
Jan-12 Jan-13 Jan-14 Jan-15	Jan-16 Jan-17 Jan-18
Residual (RHS)	Actual	Fitted

Source: Bloomberg, Haver, IBES, MSCI, Datastream, UBS

Our bottom-up numbers agree with the top-down

The latest run of our bottom-up GEM Inc. database points to 6.8% EPS growth next year vs an IBES consensus forecast of 10.6% (Figure 93). Among the 10 stocks that have the biggest weights in the MSCI EM index, our analysts have below-consensus earnings assumptions on four of the five biggest EM IT names – Baidu, Samsung Electronics, Alibaba and Tencent – and also for Naspers. There are only three companies among the top 10 MSCI EM constituents for which the UBS EPS forecast is above consensus – Ping An Insurance, China Mobile and TSMC (Figure 94).

UBS analysts have belowconsensus 2019 EPS forecasts for big EM tech names and Naspers

Figure 93: EPS growth forecasts: UBS GEM Inc. vs IBES consensus

25%
	22.2%
20%	19.1%			UBS GEM Inc.		IBES consensus
		13.4% 13.5%
15%			10.6%		11.1%
10%					8.9%
			6.8%
5%
0%
	2017	2018E		2019E		2020E

Source: IBES, MSCI, Datastream, GEM Inc. – September 2018, UBS estimates

Figure 94: Percentage deviation of 2019 calendar year UBS EPS estimates from Bloomberg consensus

	10%
		7.2% 6.4% 5.7%
	5%
	0%
					-0.2% -0.7%		-2.2%
	-5%
	-10%							-8.1%	-12%
	-15%
	-20%									-16% -17%
		Ping An	China Mobile	TSMC	ICBC	CCB	Tencent	Naspers	Alibaba	Samsung Elec.	Baidu

Source: Bloomberg, MSCI, Datastream, UBS estimates

Understanding the size, sector and country reads

The small size of the cuts in the 2018 earnings base since the start of the year can be attributed to the smaller cuts in the Large-Cap segment of the MSCI EM index. The Mid-Cap and Small-Cap segments (the latter is outside the MSCI EM standard family) have had their 2018 EPS forecasts revised lower by 4.2% and 14%, respectively (Figure 95).

Large Caps have helped the 2018 EM EPS level forecast to hold its ground

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Figure 95: 2018E USD EPS YTD revisions across sizesegments of MSCI EM

Figure 96: Sector contribution to 12m forward P/E derating since market peak (26 Jan 2018)

0%							13.5
-2%	-0.7%	-1.1%					13.0
							12.5
			-2.2%
-4%
							12.0
-6%				-4.2%			11.5
-8%							11.0
							10.5
					-8.3%
-10%
							10.0
-12%							9.5			ConsDisc	StaplesCons	Industrials	Financials	HealthCare	IT	Telecoms	Utilities	RealEstate	Oct31on 18
							Jan26on 18	Energy	Materials
-14%						-14%
-16%
	Large Cap	Standard	IMI	Mid Cap	SMID	Small Cap	EM												EM

Source: Bloomberg, MSCI, Datastream, UBS	Source: IBES, MSCI, Datastream, UBS
Note: 'IMI' is the 'Investable Market Index', which is an aggregate of Large-, Mid-
and Small-Cap segments. 'SMID' represents Mid and Small Caps, and the
'Standard' segment is the aggregate of Large and Mid Caps.

The two sectors that contributed the most to the EM valuation de-rating are energy and materials (Figure 96), and these are the only two sectors that are seeing further EPS upgrades (Figure 97). This suggests that the market views the recent spurt in earnings in these sectors, driven largely by supply shutdowns in China and elsewhere, as unsustainable. In EM IT, the share price weakness has been a function of EPS downgrades as the sector's P/E ratio has been virtually unchanged since the market peak.

In 2019, the consensus forecast is for EM to see stronger earnings growth vs DM across a number of sectors (Figure 98). However, with the exception of EM consumer discretionary, this is driven by smaller sectors. EM IT and financials are both expected to post subpar earnings growth relative to the MSCI EM average.

Energy and materials have seen the biggest valuation compression as their earnings forecasts are seeing further upgrades

Figure 97: Sector contributions to MSCI EM 6m revisions	Figure 98: 2019 earnings growth in EM and DM by sector
in 12m forward earnings

8%					30%
6%					25%	24% 23%							EM		DM
																24%
					25%
4%
								21%
2%					20%
0%					15%			15% 15%
-2%											12% 11% 10%
						10%								9%			9%
-4%					10%							9%
								7%	7%	7%			8%		8%
-6%					5%						4%				6%		4%
					5%
-8%
							0%
-10%					0%
						DiscCons	EstateReal	CareHealth	StaplesCons	Industrials	Materials	Overall	Financials		Telecoms	Energy	TechInfo
-12%					Utilities
2014	2015	2016	2017	2018
	Energy	Materials		Cons Disc
	Cons Staples	Financials		IT
	Others	MSCI EM
Source: IBES, MSCI, Datastream, UBS					Source: IBES, MSCI, Datastream, UBS

Across countries, three big EMs – one from each of the three major EM regions – are forecast to deliver earnings growth of over 20% next year: India, South Africa and Brazil. China – the biggest market in MSCI EM – is also expected to see aboveaverage earnings growth of 15% next year (Figure 99). In Brazil, politics permitting, the 21% earnings growth expectations may even be overshot, but we

2019 consensus EPS growth forecasts for China, India and South Africa appear elevated to us

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think the consensus expectations are too high in India and South Africa. Also, the recent tightening of local credit conditions in China and India is likely to restrain earnings growth there. Our India equity strategist, Gautam Chhaochharia, has a negative outlook on the market, which he presents in the box on the next page. However, should liquidity easing take place in China, there may be a case for rerating in valuations, even with slower earnings growth.

Figure 99: 2019 earnings growth by country in local currency terms

25%		24%	21%	21%
20%
				16%			15%
15%
								13%	12%
											11%
												10%	9%			9.4%	9.2%
																		8.6%
10%
																		6.7%			5.8%
5%																						3.8%
																								2.6%	2.5%
																										0.6%
0%
		IN	ZA	BR MX CN				PH		ID	EM	TR		EU		PL	US DM TH MY					JP		TW	KR	RU
						Asia				EMEA					LatAm					EM				DM

Source: IBES, MSCI, Datastream, UBS

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