Element cautions of earnings and quick recovery

Cape-based specialist fund manager, Element Investment Managers, has expressed concern about the sustainability of company earnings and the optimism of a quick earnings recovery that is being built into certain share prices.

Chief investment officer Terence Craig said the fund manager expects to see many earnings disappointments for the reporting period ending June 2009, given the high comparable earnings base to June 2008.

“Many commentators are expecting companies to return to their 2008 earnings levels within the next few years. However, we do not share this view.”

“We are also concerned that the quality of earnings is deteriorating at the same time. There is much window-dressing in our industry and this tends to be compounded during tough business environments. Investors must be wary of accepting company statements at face value,” he said.

Element Investment Managers, which changed its name from Frater Asset Management this week, manages funds of over R15 billion.

Craig said much has been written about the “green shoots” of economic recovery internationally as commodity prices and stock markets rallied during the June quarter.

“We would caution that much of the positive news appears to stem from the momentum of price moves rather than economic fundamentals.”

Citing the example of bank failures in the US, Craig said there were no bank failures in 2005 and 2006, three failures in 2007 and 25 in 2008. However, for the first half of 2009 there have been 52 bank failures in the US, more than double the failure rate for the entire 2008.

“This is not a trend that gives comfort that the worst is behind us,” he said.

“Investors will have to accept slower growth and increasing regulation and government intervention in economies both locally and internationally. Returns from asset classes are likely to be lower than what we have become used to in the bull market. Massive credit bubbles that grow over a number of years are unlikely to unwind and correct in a short period.”

Craig said Element Investment Managers remains cautiously positioned in the current tough and volatile earnings environment.