For the first time in more than a year analysts are cutting their forecasts for Standard & Poor�s 500 Index earnings, jeopardizing gains from the biggest September rally since World War II.Earnings Estimates A Mirage
Estimates for S&P 500 companies� combined 2011 profit fell as low as $95.17 last month from an August high of $96.16 and posted the first quarterly reduction since the three months ended June 2009, according to more than 8,500 analyst forecasts tracked by Bloomberg. The revision came as the benchmark gauge for U.S. equities rose 8.8 percent last month, the largest September advance since 1939.
Estimates show S&P 500 earnings may rise 15 percent in 2011, down from a forecast of 20 percent growth in March, Bloomberg data show. The S&P 500 slipped 0.2 percent to 1,146.24 last week amid lingering concern that Europe�s government debt crisis may threaten the economic recovery.
Companies in the S&P 500 may report profits rose 23 percent on average during the third quarter, according to forecasts tracked by Bloomberg. That�s about half the 49 percent growth during the second quarter and the 52 percent increase from January through March.
Michael Levine of OppenheimerFunds Inc. says the outlook for lower earnings is already reflected in stock prices after the S&P 500 fell as much as 16 percent between April 23 and July 2. He predicts equity prices will keep rising as investors grow more confident that the U.S. economy isn�t headed for the second recession in three years.
�Equities are cheap,� said Levine, a money manager at New York-based OppenheimerFunds, which oversees about $165 billion. �The broader markets are assuming there�s a slow but gradual recovery. As long as that�s the message, the markets will be fine.�
�Stocks go up and they raise their earnings estimates, the markets go down they start reducing estimates -- a lot of it has to do with the psychology,� said Jeff Saut, chief investment strategist at Raymond James & Associates, which manages $235 billion in St. Petersburg, Florida. �Over the long run, investing is indeed all about the earnings, but over the short term it�s all about psychology.�
It's important to understand why earnings have gone up: Trillions of dollars of stimulus worldwide that is not sustainable. Bank earnings estimates have been inflated by massive extend-and-pretend games encouraged by the Fed with a blind eye from the FASB.
Moreover, the FASB has delayed mark-to-market accounting rules and has still not forced banks to bring SIVs and off-balance-sheet assets back on the books. Those assets are held at inflated values.
It is disgusting to hear those like Michael Levine of OppenheimerFunds Inc. says "equities are cheap". Equities only look cheap if you use absurd forward earnings estimates, and ignore future writeoffs and other "one-time" items that seem to have a way of recurring with remarkable regularity.
Stocks Not Cheap
Stocks are not cheap an besides, share prices are not always a direct function of earnings. I talked about that in Sure Thing?!
Earnings vs. Share PricesFancy Numbers
Right now, sentiment is so bullish and earnings estimates so lofty there is room for hefty earnings expansion that falls short or estimates. Buying stocks that miss wildly optimistic earnings estimates is not likely to work out well.
Furthermore, even if earnings do come in on target, there is no historic guarantee that stock prices follow. For example, on March 31, 1973 the S& P was at 111.52 with trailing earnings of $6.80. Seven years later, on March 31, 1980 the S&P was at 102.09 with trailing earnings of $15.27.
Thus, over a span of seven years, earning rose 125% while stock prices fell 8.5%!
What happened? The PE ratio on the S&P fell from 16.40 to 6.68, that's what.
Moreover, those were real earnings then. Now, corporations hide garbage in SIVs with the blessing of the Fed and analysts cite pro-forma earnings that throw out "one-time" charges that occur with increasing regularity.
Thus, anyone who says stock prices will go up because earnings go up, does not understand history.
�You need pretty fancy GDP numbers to get to $95 a share in earnings next year,� said Robert Doll, vice chairman of New York-based BlackRock Inc., which oversees $3.2 trillion. �Our view is that they�re still a little too high, and that nobody believes them.�
Robert Doll is half-right. He's right in that "You need more that fancy earnings to get to $95 a share". He's half-right because the consensus believes. Bear in mind we could still see a bit of earnings expansion, but with the inventory replenishment and stimulus coming to an end, and with consumers heading back into a shell, it will not be sustainable.
Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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