Analysts Forecasts Remain Too High
Well, now that we got THAT unpleasantness behind us, its time to look forward to earnings season! Its not going to be pretty. The question is from these still depressed levels, will there be any further damage wrought.
On that exact subject, I hope in the midst of the recent market activity, you did not overlook this article about earnings expectations. Its the key to where markets will eventually find themselves after the current bailout mania subsides.
As we have repeatedly harped upon this year, the analyst community is still way too bullish when it comes to S&P500 earnings consensus.
"Investors who are expecting a rebound after almost $7 trillion was erased from U.S. equity markets this year may be disappointed as earnings fail to match forecasts. S&P 500 companies that earned less than analysts estimated in the past year dropped 13 times more than the index's average decline, data compiled by Bespoke Investment Group LLC show...
Operating profit at S&P 500 companies fell 7.5 percent last quarter and will jump 28 percent this quarter, led by banks and brokers, according to analysts' estimates compiled by Bloomberg. That would exceed the record $222 billion they earned in the April-June period last year.Six of 10 industries will report record profits or come within 5 percent of all-time highs, according to Wall Street projections, which are usually based on company outlooks.
"The consensus will have to go down significantly,'' said John Praveen, Newark, New Jersey-based chief investment strategist at Prudential International Investments Advisers LLC, a unit of Prudential Financial Inc., which oversees $638 billion. "The numbers are way too high.''
Indeed.
The Street is at $95, and I am at $65 . . . times a 15 multiple means we are actually near fair value. As long as earnings don't fall even below my pessimistic forecast -- and multiple compression doesn't rear its angry little head.
If that happens, all bets are off . . .
>
Previously:
Pricey Markets? (September 03, 2008)
http://bigpicture.typepad.com/comments/2008/09/pricey-markets.html
Analysts Overstate Earnings Once Again (July 30, 2008)
http://bigpicture.typepad.com/comments/2008/07/analysts-overst.html
S&P500 Profits Ex 3 Oil Cos = Awful (May 19, 2008)
http://bigpicture.typepad.com/comments/2008/05/sp500-ex-energy.html
Source:
U.S. Stock Analysts Keep Estimates as Markets Fall
Michael Tsang
Bloomberg, Oct. 13 2008
http://www.bloomberg.com/apps/news?pid=20601010&sid=aOp.zaooow_I&
Wednesday, October 15, 2008 | 09:00 AM | Permalink
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Before the dot-com days, someone who used a 15x P/E was considered a moderate, reasonably cheery optimist, kind of like a moderate Republican then would be considered a liberal Democrat now. If I recall the old idiom, the P/E should be roughly equivalent to the annual growth rate of a company (I believe either top line or bottom line could be used), which means to justify your 15x P/E, the entire S&P would have to grow at 15% annually. I suspect your recent mean-variance experiences - despite having read Taleb - is causing you to be optimistic on earnings as well.
Dow 6000 (7000 with Obama, 4000 with McCain, probability adjusted)
Posted by: CNBC Sucks | Oct 15, 2008 9:15:50 AM
Since tax rates were cut but Bush, eventually... eventually supply side economics proves - with not a scintilla of doubt - that more tax revenues will come in to cover the deficits (about which you shouldn't care.)
Someone needs to tell this story - the real story - "the greatest story never told."
Posted by: VennData | Oct 15, 2008 9:19:50 AM
we are still in the early stages of the great credit and debt unwind. a maniacal 20 year cycle that ended with the biggest bubbles in the history of finance. to believe equities deserve a 15 multiple is highly optimistic. when all is said and done single digit PE's will emerge, one cannot rule out stocks trading at japanese equivalent lows of dow 2400 s+p 243
Posted by: harold hecuba | Oct 15, 2008 9:23:31 AM
I think a 12 multiple is appropriate as an upside target.
How do come up with your $65 in earnings?
Do you have a team of fundamental analysts going through 10K's and making models?
Or just a guess?
Posted by: Vermont Trader | Oct 15, 2008 9:30:51 AM
The five year average reported (not operating) earnings for the S&P 500 is $64. 14 times is 910. My opinion is that 850-950 is a good value. Anything below 800 is cheap. FYI, the ten year average is $54.
Posted by: Mike M | Oct 15, 2008 9:41:24 AM
Mata Hari blew a kiss to her executioners when executed on this date in 1917. I have seen the economic numbers this morning..not the end of the world, too much liquidity for that. But certainly looks like the recession will be quite significant.
Mata Hari knew how to take bad news....
Posted by: Bruce in Tennessee | Oct 15, 2008 9:46:58 AM
"...that more tax revenues will come in to cover the deficits (about which you shouldn't care.)"
Venn, that's some world class snark. Deficits don't matter! You tell 'em!
Posted by: weinerdog43 | Oct 15, 2008 9:52:45 AM
Another round of selling within days/hours, bad earnings picture obviously not pricing in!!! Selling climax last Friday? No way!
Posted by: Ben | Oct 15, 2008 9:59:46 AM
OK guys, a little information....
What is your general idea about the PST over the next year or two?
Looks like earnings are, as Barry says, too high..what about bond rates?
Leftback? Steve? Karen?
Posted by: Bruce in Tennessee | Oct 15, 2008 10:05:46 AM
I agree with Mike M:
Somewhere between 900 and 1000 on SPX is about where we should be for value folks to start taking a dip, approx 14x E.
How much further can we realistically fall, as we'll see in the guidance (which is always a tough sell at best) I doubt we are seeing as much deterioration in E as we have priced in as of today.
I agree that EXPECTATIONS should be ratcheted down, but in the end thats a good thing as it will create more upside going fwd.
The truth of earnings will set us free...
Its just that first it will make us miserable.
Expectation sobriety check we've seen so far:
MOS
RIMM
GE
BAC
We should be keeping a list.
Posted by: I-Man | Oct 15, 2008 10:09:59 AM
At times like this, it seems illogical to rely on fundamentals, technicals, economic indicators or sentiment for guidance.
Perhaps logic is all we have now, which would have us tune out noise and disallow the admittance of damaging emotion.
If we ascribe to the belief that the four most dangerous words for an investor is, "it's different this time," then we may logically deduce that the markets are not as strong as the most optimistic believe and not as weak as the most pessimistic believe.
"Bad reasoning as well as good reasoning is possible; and this fact is the foundation of the practical side of logic." ~ Charles Sanders Peirce
Posted by: Kent @ The Financial Philosopher | Oct 15, 2008 10:13:17 AM
Mike M wrote:
"The five year average reported (not operating) earnings for the S&P 500 is $64. 14 times is 910. My opinion is that 850-950 is a good value. Anything below 800 is cheap. FYI, the ten year average is $54..."
Why is the five-year average during a bubble economy and an oil-at-all-costs presidency a more accurate measure than the ten-year average?
Posted by: mitchn | Oct 15, 2008 10:19:25 AM
CNBC Sucks: that logic is absolutely ridiculous. Even theoretically, the PE ratio should not equate with the growth rate of a Company. You would be better served to take the earnings yield for a stock (the inverse of the PE ratio) and compare that to anything you choose: 10Yr Treasury rate, AAA-rated bond rate, etc.
FYI, that figure looks far better today than it has in decades. It also looks better today than it did after the crash in 1929 and the crash in 1987.
Someone brought up Shiller's valuation analysis. I study his data religiously. In my opinion, his analysis leads me to believe that equities are reasonably priced at these levels. At the recent lows, we were at about 14x 10Yr. Avg. Earnings. It seems at the worst of times, we've reached single digits, implying a possible downside from here of a further 33%. However, that assumes the worst of times. We could just as easily stay flat or skyrocket back up to 20x.
However, anyone who claims that the stock market is OVERVALUED at current levels based on historical precedents is misinformed.
Posted by: Adam | Oct 15, 2008 10:23:36 AM
An interesting Technical point:
On a monthly candlestick chart of SPY:
May 2003: SPY breaks out of bear market downtrend at approx 95-96
October 2008: SPY after the panic of last week, found some support at the end of the week at 95-96
So technicals are still at work here, and 95 on SPY is critical... if we can hold 95-96 it makes a short term bottom case look solid... we'll see what earnings does to this, but a good exchange of TA and Fundies at work here in this market, it aint all illogical.
Posted by: I-Man | Oct 15, 2008 10:38:01 AM
Um, S&P already lowered the estimates for the Index significantly over the last few days for "as reported earnings per share". Go to their site and you can see the spreadsheet at:
http://www2.standardandpoors.com/portal/site/sp/en/us/page.topic/indices_500/2,3,2,2,0,0,0,0,0,1,5,0,0,0,0,0.html
Here is the revision from the last few days (EPS per share for the index)...
Previous:
9/2009 15.42
6/2009 14.64
3/2009 15.58
12/2008 14.68
9/2008 16.14
New forecast:
9/2009 11.89
6/2009 11.47
3/2009 13.48
12/2008 12.12
9/2008 13.99
Posted by: Big J | Oct 15, 2008 10:48:36 AM
Why a P/E of 15? Don't multiples typically compress during a bear market... and expand during a bull market? From an historical standpoint what was the P/E at the bottom of the markets during the last bear markets? 7-8?
Posted by: jlj | Oct 15, 2008 11:11:59 AM
mitchn wrote:
"Why is the five-year average during a bubble economy and an oil-at-all-costs presidency a more accurate measure than the ten-year average?"
I never said using the five year average was preferable. Use what you want. Value is subjective. My opinion is $65 is reasonable to use as an earnings number.
Value is relative. The S&P 500 now yields 3.3% Clearly dividends can go down in the short run but it will grow over time. The ten year treasury is at 4%. If you have anything more than a six month time frame, stocks are pretty decent values (although they could get much cheaper).
Posted by: Mike M | Oct 15, 2008 11:15:51 AM
The thing is, a P/E ratio of about 15 is an average over many decades, which includes both bull and bear markets. However, the actual P/E ratio behaves cyclical around this average. It usually goes above 15 during bull markets and below 15 during bear markets. (The last bear market from 2000 to 2002 was an exception from this pattern). Especially, the P/E ratio seems to have a 30 year cycle. About every 30 years the P/E ratio hits a low of about 7 during bear markets. See following long term time series:
http://media.ft.com/cms/4cc062f4-cc10-11db-a661-000b5df10621.gif
The last time the P/E went significantly below 10 was in the year 1980. The current 30 year cycle is almost over now. Considering that the credit bubble, which has built up since the 1980s, is deflating now and that we are facing a major recession, to assign a high probability to an additional decline in the stock market until the P/E ratio has reached a value of less than 10, doesn't seem unreasonable.
Just to take the long term average of the P/E ratio of 15, like Barry does here, as a metric for a "fair" index value of the S&P500 is a fallacy, since it doesn't take into account the cyclical behavior of the P/E ratio. It's like stating the expectation that the temperature won't go below freezing in winter, because the average temperature over the year was about 15 deg. C (59 F).
Thus, let's say the the P/E ratio will be going down to 10 to 7 during this bear market. Using Barry's assumption for earnings, that means an additional decline of the S&P500 index by about 30% to 50% from the current value of 950.
rc
Posted by: rootless cosmopolitan | Oct 15, 2008 11:26:44 AM
Lets not forget that it was the Real Estate market that got us to where we are, and if its not done then the stock market is not done.
Roubini thinks that Real Estate has another 15% to go. If that is true, then aren't we looking at another wave of deleveraging as the Alt-A loans become the new subprime?
Posted by: BarryB | Oct 15, 2008 11:42:33 AM
The Street is at 95? What Street is that? Std & Poors has top-down Operating Earnings for 2009 at 62.40.
There are two things I haven't done since college: smoked hash and looked at 'bottom-up' earnings. They're both the same thing... pipe dreams, or dreams from a pipe.
S&P has reported earnings at 48.52 for 2009... but we all know Americans are dumb enough to think that these 'one-time' write-offs are only one time.
Thus, Americans look at operating earnings. Go figure.
The avg P/E for operating earnings 2005-2007 were about 16. 16 x 62.40 = 998.
That's why SPX closed at 998 yesterday.
P/E compression to 15 will be 936 SPX.
Once the market figures 62.40 won't be hit... just multiply 15 x the lower number.
The bottom could be 14 x 50 = 700... but that will take a few quarters for the brains on the STREET to figure out.
As I have posted on this site... SPX 900 was the optimistic low... and SPX 350 was the pessimistic intermediate 2 - 3 year low.
As always, I remain...
TG (The Great) Randini
Posted by: TG Randini | Oct 15, 2008 11:46:07 AM
Another thing: Some people posting on this site look at historical bear market p/e's to predict the future.
Unfortunately, they often miss interest rates when looking at these low p/e's (especially 73-74 and 80/82).
It appears they are using some bizarro DCF analysis to arrive at an NPV where the denominator is fixed for eternity!
Lesson? Interest rates MATTER.
School's out.
Posted by: TG Randini | Oct 15, 2008 11:59:03 AM
Margins people...margins. They mean revert and were/are at all-time highs, so there is only one way to go from here. Down. Margins will probably fall below long term averages given the great unwind we're currently in, so why shouldn't the S&P trade at 12x or less earnings? 15x doesn't scream cheap to me given the leverage being sucked out of the system. Bank ROEs? about about 12% or less on those.
Posted by: Lloyd | Oct 15, 2008 12:00:12 PM
"Analysts Forecasts Remain Too High"
That's their lipstick on a pig slant. After all they are sales people.
Posted by: Pat G. | Oct 15, 2008 12:10:20 PM
Your friendly neighborhood short seller says:
higher risk shorting the index, but still decent chance of another 10-20% upside (meaning downside to you longs) from here.
more to the point, retail & basic materials/commodities still have further to go.
Going back to S&P, earnings will disappoint in aggregate because energy stocks will disappoint. ditto point about profit compression, which will keep E down, and P/E too high.
As always I remain :) your friendly neighborhood short seller.
Posted by: David | Oct 15, 2008 12:16:23 PM
Barry, are you still feeling that we will get a rally, or was Monday it?
I have the idea that things are still waiting for the Europeans to finalize the bailout at their meeting and then Libor will fall significantly and we get more than a one day rally.
Posted by: Mike in NOLa | Oct 15, 2008 12:17:56 PM
