General Motors-GM reports Q3 EPS ($4.45) vs. consensus of ($3.70)
Reports Q3 revenue $37.94B vs. consensus of $39.41B.
Note that earnings were originally scheduled to be released at 10:30
Market shrugging this off, with the Dow up175
SPX Earnings & Multiples ?
There's an interesting article in today's WSJ in which (coincidentally), I have a brief quote in:
"The financial system is undergoing a sea change that is forcing a global sell-down of assets. Even when this is complete, there is likely to be greater restraint when it comes to the use of borrowed money to juice returns. At the same time, investors are likely to demand a far higher price to take on risk than in the past. Even if financial stocks feel the brunt of these changes, few, if any, industries will be unaffected.
That argues for prices that reflect reduced expectations of future profits. Yet consensus estimates peg 2009 aggregate operating earnings for companies in the Standard & Poor's 500-stock index at about $94 a share, according to Thomson Reuters. That figure assumes earnings growth both this year and next.
If those estimates panned out, the S&P on Friday would have traded at what looks like a bargain multiple of about 9.3 times forward earnings. Shift earnings to the lower end of the consensus range, about $75 a share, and the multiple rises to 11.7 times.
That still might seem cheap compared with multiples that often exceeded 20 times during the 1990s. But it is well above trough valuations of about eight times seen during the depths of the 1970s bear market, according to data from UBS. And the economic outlook, along with the unwinding of the credit bubble, means it is unlikely that earnings will increase this year or next. The better question is how far they will fall.
Bears are well below the consensus in their answer. Barry Ritholtz, director of research at Fusion IQ, for example, says he reckons that 2009 earnings could drop to about $50 a share. In that case, even a multiple of 14 times would bring the S&P to about 750 -- nearly 15% below current levels."
Good stuff . . .
Autumn Is Here. Now for the Fall...
WSJ, OCTOBER 25, 2008
Bank Earnings Are Fugly !
Wow, this is some collection of disasters:
The exceptions? Wells Fargo, JPM:
Dogbert the CEO
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.''
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 . . .
Pricey Markets? (September 03, 2008)
Analysts Overstate Earnings Once Again (July 30, 2008)
S&P500 Profits Ex 3 Oil Cos = Awful (May 19, 2008)
U.S. Stock Analysts Keep Estimates as Markets Fall
Bloomberg, Oct. 13 2008
Understanding the Significance of Mark-to-Market Accounting
"Suspending mark-to-market accounting, in essence, suspends reality."
-Beth Brooke, global vice chair, at Ernst & Young
Misinformation, bad dope, and spin seem to be dominating the current discussion on Mark-to-Market accounting. Let's see if we cannot simplify the arcane complexity of the accounting rules regarding FASB 157.
Understand why this is even an issue: Many banks, brokers, and funds chose to invest in certain "financial products" that were difficult to value and were at times thinly traded. If you are looking for the underlying cause of why some arcane accounting rule is an issue, this is it.
In my office, we don't buy our clients beanie babies or Star Wars collectibles or 1964 Ferrari 275GTBs. We purchase stocks and ETFs and bonds and preferreds for them (some clients also own options and commodities). Why? Because we believe -- and our clients have insisted upon -- the need for instant liquidity. Nothing we have purchased cannot be liquidated on a moments notice. We know what the fair value of these holdings are second by second.
While we may have been tempted by potential greater returns that some of these other products offered, we simply could not justify the risk of owning hard to value, thinly traded, hard to sell items. And, we never had to rely on the models of the individuals who created and sold us these products in the first place, to determine an actual price. If ever a product was rife with self-interested conflicts of interest, this one is it.
That is one of the key elements of the current situation. A decision was made to bypass the broad, deeply traded traditional markets (Equities, Fixed Income, Commodities and Currency) and instead create new markets for new products. No one should be surprised that the net result was a flawed system of garbage paper, with too little room at the exits in case of emergency.
Let's puts this into some context:
"Accounting is a way of portioning economic results by time periods. It doesn’t affect the cash flows, but tries to allocate economic profits proportional to release from risk. If we were back in an era where the financial instruments were simple, then the old rules would work. But once you introduce derivatives, and securities that are called bonds, but are more akin to equity interests, you need to mark them to market."
Exactly. Otherwise, you are left with public companies, who have made capital allocation and investment decisions that are hidden from their owners (shareholders) and the investing public.
Now that the garbage is on the books, no one wants to admit the original error of purchasing this class of assets. Its not just that the trade has gone bad, its the original buying decision was so flawed even if the trades were not such giant losers.
Recent actions of corporate titans in the financial sector are essentially an admission that their business model was deeply flawed. No one would invest any capital for a ROI of 50 bps per year. They of course knew this -- so they leveraged up that 50 bps 35X or so, creating the false appearance of more attractive returns. This higher risk, potentially higher return paper was part of that misleading process.
Suspending FASB 157 amounts to little more than an attempt to hide this broken business model from investors, regulators and the public. Its not just getting through the next few quarters that matters; Rather, its allowing the market place to appropriately reallocate this capital to where it will serve its investors best. That is what free market capitalism is, including Schumpeter's creative destruction. (A WSJ OpEd today get this issue precisely wrong).
I have been steadfast over the past 2 years about why I did not want to own any of the financials that held this paper on its books. The key was that we could not figure out what the liabilities were relative to the assets. That is investing 101.
If FASB 157 is suspended, I would advise our clients and the investing public that owning any financials that failed to disclose their holdings accurately were no longer investments -- they were pure speculations, with more in common to spinning a roulette wheel than owning Berkshire Hathaway (BRK) or Apple (AAPL) or Google (GOOG). Indeed, I know of no faster way to end up on the DO NOT OWN list than to hide from your shareholders what is on your books.
If investors cannot trust the valuations of what is on a firms books, they simply cannot invest in these firms PERIOD.
There are other alternatives for the institutions that now must deal with this discounted, thinly traded hard to value junk paper. They can sell it for whatever price a the market will bear, they can spin it off into a separate holding company, they can write it down to zero and reap the rewards of mark ups in future quarters.
But suspending the proper accounting of this paper is the refuge of cowards. It reflects a refusal to admit the original error, it hides the mistake, and it misleads shareholders. I find it to be totally unacceptable solution to the current crisis.
As Japan learned, not taking the write downs only delays the day of reckoning. They propped up insolvent banks, and suffered a decade long recession for it. That way disaster lay . . .
S&P500 ex-Risk ? (November 06, 2007)
Summary of Statement No. 157
Fair Value Measurements
Auditors Resist Effort To Change Mark-to-Market
WSJ, SEPTEMBER 30, 2008, 4:29 P.M. ET
What part of mark-to-market don't you understand?
Time's Curious Capitalist, September 30, 2008 8:17
SEC, FASB Resist Calls to Suspend Fair-Value Rules
Bloomberg, Sept. 30 2008
How to Start the Healing Now
Fix accounting rules and private money will come.
WSJ, OCTOBER 1, 2008
Single Digit Financial Midgets
Out of 254 financials in the S&P 1500 Composite Financial sector, 12 meet the criteria of being under $10, and having been over $20 in the past 3 years: CNB, ETFC, WM, HBAN, LEH, NCC, SOV, DRH, MTG, TSFG, BPFH, PBKS.
Thanks to Mike Panzner for the data screen
Why the Bear Is Alive and Well: P/E
A column in the Sunday NYT purports to look at Why the Bear Is Alive and Well. While the main thrust of the column is on point -- namely, stocks remain too expensive for a true bear market bottom -- I have one small issue. It revives a meme that won't die -- namely, that Earnings ex-Financials are pretty good:
"Corporate earnings were being distorted by troubles in just one sector: the financials. According to S.& P., earnings for financial companies are expected to drop about 70 percent this year versus 2007. That accounts for most of the profit drop for the overall market...
Jeffrey N. Kleintop, chief market strategist at LPL Financial in Boston, also noted that based on “forward earnings” — projected profits, as opposed to actual results — the market P/E is already quite modest. Consensus earnings forecasts from Wall Street analysts for 2009 work out to a forward P/E of around 12 for the S.& P. 500."
As we have shown over the years, relying on Wall Street's forward earnings is a formula for losing money -- lots of it. Indeed, relying on nearly anything out of Wall Street is a suspect strategy. Better to cherry pick the best of what the street produces, and ignore the vast majority of what has been shown to be conflicted, self interested, compromised junk.
Rather than spin earnings to justify a long and wrong position, let's consider a variety of factors and scenarios. Think about these 3 mind experiments:
• What are the S&P500 earnings currently if we back out the 3 largest oil companies? (ex oil, they are down 30%)
• What would SPX P/E have been over the past 5 years, when the P/E was artificially lowered due to earnings we now know were based on imprudent speculation by all of the financials? (Much higher)
• If we remove the upside and downside outliers -- Energy & Financials -- what have the SPX P/E ratio been for the past 4 quarters? (mediocre and overstated by Wall Street)
My point? Merely taking away the negative results caused by reckless speculation by irresponsible management informs us of nothing. What do you learn if I show you that during my youthful baseball career, I was a .600 hitter? Oh, I have to add that number is, of course, ex-strikeouts . . .
Well, at least our boy Rosenberg gets it right:
"Of course, Wall Street earnings projections have been way too optimistic in recent quarters, and David A. Rosenberg, the Merrill Lynch economist, thinks that they may still be too rosy. In a recent economic commentary, he says Merrill is expecting S.& P. 500 earnings to continue to decline through 2009. In fact, he says he thinks profits of the S.& P. index will come in at around $63 a share next year. That’s down from the $68 he is forecasting for this year, and a far cry from the $100 that Wall Street is expecting for 2009. Using his projection, the market’s forward P/E would be nearly 20, not 13. If he’s right about earnings, it may be a while before a new bull can emerge.
I am currently forecasting $65 SPX earnings, and a 15 PE gets you to about 975. There is a significant chance I revise this lower in the coming quarters; I have seen respectable forecasts of $57, and some as low as $48. It all depends upon how deep and prolonged the current recession will be . . .
Analysts Overstate Earnings Once Again (July 30, 2008)
S&P500 Profits Ex 3 Oil Cos = Awful (May 19, 2008)
S&P500 ex-Risk ? (November 06, 2007)
Why the Bear Is Alive and Well
PAUL J. LIM
NYT, September 6, 2008
Soc Gen: Meltdown Imminent
When people try to figure out what was the cause of today's 344 point whackage, one of the items they will point to will be SocGen's alert today from Albert Edwards:
***Alert****Economic and equity market meltdown imminent****Alert***
Last week saw the publication of Q2 US whole economy profits data. They were shockingly bad. Core measures of profitability are in free-fall and have now reached a tipping point, where corporate activity could easily implode. We have also reached the point where companies give up ‘manipulating’ their profits higher and admit they are actually in free-fall. A combination of economic and reported profits slumping will catalyse the next equity downleg.
I always look askance at such precisely timed alerts -- firstly, because timing markets this precisely is extremely difficult, and second, if memory serves, this is not the first such alert from SocGen.
As to the fundamentals of Edwards argument, he is spot on. Note our prior mention of the SocGen team was back in June (“Appalling” Market Fundamentals, Not Inflation, Is The Problem).
chart courtesy of Société Générale
Here's a brief excerpt:
US Q2 whole economy profits were shockingly poor. The headline data (post-tax) were down 6% yoy - bad but not a disaster. But our preferred measure of underlying profits (domestic non-financial economic profits -- full explanation later) is down a surprisingly sharp 17½% yoy. The last 4 quarter's average is down 12% yoy (see chart below). Typically we have now reached the point in the cycle where companies reach the end of the road on earnings manipulation and have to admit to their shareholders how bad things really are, sending reported profits diving. James Montier's recent piece "Cooking the Books" suggests that some companies may indeed be doing what the title implies. But analysts currently see no prospect of a non-financial profits slowdown, let alone recession (see table below). Why? Because companies have not yet owned up to the mess they are in and told the analysts to downgrade their numbers!
We are at a very similar point to the end of 2000, just before corporate capitulation sent
reported profits and the economy diving and the equity market collapsed.
Economists typically model corporate profits as a residual, with it dropping out of their
economic models as a function of what is happening to the economy overall. We have always believed though that corporate profits are a key driver of the economic cycle, rather than just the result of it. Historically, recessions are 'caused' (in an accounting sense) by the corporate sector. As profits decline, after a point companies finally bite the bullet and business investment slumps (see chart below). Historically, the evolution of pre-tax domestic nonfinancial profits proves to be the best explanation for company's domestic spending activity.
Hat tip: Paul Kedrosky
Global Strategy Weekly
4 September 2008
Is the best over for the U.S. stock market this year?
Here's an excerpt:
"The Standard & Poor's 500 Index, which had the worst first half since 2002, added 0.2 percent this quarter through last week, the only gain among the world's 10 biggest markets in dollar terms. Shares in the benchmark index for American equity climbed to an average 25.8 times reported profits, the highest valuation in five years. The last time that happened, the S&P 500 fell 38 percent.
Money managers at Federated Investors Inc., Russell Investments and Morgan Asset Management, which oversee a combined $600 billion, said the gains won't last because corporate profits will fail to meet analysts' estimates. Wall Street forecasters, who were too optimistic about earnings for the past four quarters, predict income at America's biggest companies will grow by a record 62 percent in the final three months of 2008, according to data compiled by S&P...
Analyst estimates were at least 26 percentage points too high since the fourth quarter of 2007 as they failed to anticipate more than $500 billion of subprime-related bank losses and a slowing economy, according to data compiled by S&P and Bloomberg."
Note that S&P 500 earnings consensus is for $21.69 in Q3 -- up 3.9% from a year ago. In Q4, the consensus is for $24.62 a share, up a whopping 62% from last year (these are weight adjusted estimates).
We've noted this valuation issue repeated this year, as well how wrong the analyst community has been. Combine the two, and you end up with a very challenging environment.
U.S. Stocks at 25.8 Times Profit Means Rally May End
Michael Tsang and Jeff Kearns
Bloomberg, September 2 2008