LONDON Exuberant global markets have taken a reality check this month on chronic U.S., Chinese and European growth concerns, and investors should hold companies' relatively rosy profit outlooks up for scrutiny too.
"Cheap" valuations based on historical price/earnings ratios have kept many investors bullish on world equities over the past three years despite what now appears to be routine economic disappointment and seemingly shorter business and profit cycles.
But there is growing anxiety that temporary sentiment and stock price boosts related to central bank money printing and emergency lending bear little relation to the long-term profit outlook, among non-financial firms at least.
Even though 12-month forward price/earnings ratios for world equity look good value, periodic pops in prices have increasingly not been matched by rises in earnings projections which have started to move sideways.
As ever, either the price in this P/E ratio is indeed cheap or earnings projections need a reality check too and historic valuation averages are restored by a drop in the profit outlook.
Macroeconomic hopes hinge on a U.S. recovery gaining more traction, a soft landing of Chinese growth to about 7.5 percent from the double digits of the past decade and a resolution of euro zone's systemic sovereign debt and banking problems.
All three of these, however, were in doubt again in April and the anxiety knocked some 5 percent off MSCI's world equity index .MIWD00000PUS from their March peaks. That leaves stocks still up 8 percent on the year but, just like last year, the price momentum and direction seems to have stalled.
Even though bouts of central bank money-printing and cheap lending in the United States, Europe and elsewhere periodically offer a fillip, as the European Central Bank's money flood did again spectacularly in the first quarter, the effect on the real economy and market prices tends to fade fast.
In the event, the P of the PE ratio advances and retreats, but not the E - leaving bulls to state their case continuously on each pullback but pessimists to question the whole construct.
"Do people really think E would be as good without the massive QE (quantitative easing)around the world?" asked hedge fund manager Stephen Jen at SLJ Macro Partners.