Stock Market Week: Top down, bottom up, it's still a mug's game

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The Independent Online
IF FORECASTING is a mug's game, then the stock market can boast two types of mugs.

When it comes to predicting companies' future earnings, market specialists fall into two conflicting and fiercely opposed camps. In the red corner sit the "top-down" forecasters, the strategists and economists who base their earnings per share (EPS) predictions on the impact of the domestic and global macro-economic outlook on businesses. Facing them in the blue corner, the "bottom-up" predictors, the analysts who look at individual firms and derive their forecasts from company and sector-specific issues.

The division between the "macro" strategists and the "micro" analysts can have profound influences on investors' attitudes towards stocks. Since the two camps disagree on almost everything, siding with one or the other can make the difference between a successful portfolio and a series of losing punts. Take the latest forecasts. Top-down supporters take thegloomy view that in 1999 UK companies will grow earnings by around 5 per cent, with some super bears talking of no growth at all. But ask the bottom- up experts, and they will say the earnings of UK plcs will be buoyant, rising between 11 and 13 per cent.

The gulf stems from different forecasting methodologies. Top-down wizards look at the sluggish UK economy - set to grow by less than 1 per cent this year - and argue that companies will find it hard to drive earnings. According to them, the clouds over the European and global macro outlook will also stifle EPS growth, especially for exporters. On the other hand, the bottom-up analysts are in constant touch with companies in their sectors and are exposed to a more bullish view of the world. Firms tend to be more optimistic, and their bullishness is mainly due to two reasons. First, management needs to keep shareholders and share prices upbeat. Secondly, no company will admit that it is to lose out to competitors if the going gets tough. As a result, bottom-up forecasts made up of the sum of earnings predictions for different companies often lose sight of the fact that not all firms in one sector can be winners. However, sector analysts arebetter placed than strategists to pick up sector-specific changes which can boost earnings even if the economy is poor, such as the millennium bug for IT companies.

The theory shows that the top-down, bottom-up fight is finely balanced, but how have the two sides fared in practice? Over the past few years, it has been as uneventful as the boat race, with the top-down supporters doing a Cambridge and winning almost every year. The reason for this lies in the number of recent shocks to world economies. As unexpected crises in Asia, Russia and Latin America held back global growth, top-down strategists have been quicker to predict their impact on companies' earnings. Bottom- up predictions will probably come good once we return to a more stable business cycle as forecasts will be less prone to economic swings. For the time being, however, it is probably better to stick with the top-down gurus and go for around 5 per cent EPS growth among UK companies in 1999, rising to some 7 per cent in 2000.

Bottom-up fans will have plenty of scope to fine-tune their forecasts this week, with six FTSE 100 members set to report results.

BP Amoco, the biggest stock in London, unveils first quarter results tomorrow. Headline profits will be sharply down, say $682m (pounds 426.2m), due to the depressed oil price and poor chemical markets. However, all eyes will be on the integration of the Amoco asset base and on the first tranche of the $2bn cost savings promised at the time of the mega-merger. The other key issue is the progress of BP's other giant deal, the takeover of its US rival Arco, with particular attention focused on the cost-cutting targets.

BOC, the gas group, is also on the block tomorrow with its interims. Pre-tax profits should come in some 8 per cent lower at around pounds 177m, mainly due to another awful result in the company's vacuum pumps business. The unit has been suffering from a cyclical downturn and its profits should be over 70 per cent down on last year. The core gas business is also set to be flat given the tough industrial environment. The trading statement should provide a glimmer of hope as vacuum is recovering and the Asian crisis and the currency effects are on the way out.

The telecom group Cable & Wireless should report a slight dip in yearly profits to pounds 1.5bn, in the first results since Graham Wallace took over as chief executive from Dick Brown.

Investors will seek details of the pounds 5bn sale or flotation of the mobile phone business One2One. The merger between the cable group Cable & Wireless Communications and its rival Telewest, where Microsoft has just acquired a 29.9 per cent stake, will also be on the agenda. A sale of C&W's majority stake in the Australian operator Optus could be on the cards.

Tomorrow's interims by Imperial Tobacco should not disappoint. The cigarette- maker is expected to post a pounds 40m rise in pre-tax profits to around pounds 180m.

The insurance giant CGU reports first quarter numbers on Wednesday, with analysts widely divided on the outcome. The Dresdner Kleinwort Benson team is shooting for a pounds 16m shortfall in operating profit to pounds 150m, arguing that a pounds 70m decrease in general insurance profits will be only partially offset by lower weather claims and higher life insurance profits. David Nisbet at BT Alex. Brown is more optimistic and is going for a 32 per cent rise to pounds 225m thanks to a large jump in life profits.

British Energy, the generator, completes the blue-chip reporting week on Wednesday. Full-year profits, at around pounds 300m, will be well up on last year's pounds 276m thanks to a good performance from its electricity business. But the real question is the group's strategic direction. After missing out on the Powergen stations, British Energy is under pressure to buy a regional electricity company or to return part of its cash pile, say pounds 500m, to shareholders.

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