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