It’s that time of the year when one of the more common Wall St sellside soothsayer concoctions hit the tape, that of 2011 year end price targets. Unfortunately it’s nothing more scientific than taking a year end earnings estimate and multiplied by typically 15, the relied upon average P/E multiple over the past 100 years. When asked myself by others for one I respond, ‘I have no idea, especially now.’ Firstly, because picking an earnings estimate at a moment in time with some made up multiple is not a very sophisticated way to value things as it doesn’t take into account any assumed long term growth rate and the cash it generates, doesn’t adjust for the current near record high in corporate profit margins which is a mean reverting statistic and assumes no change in interest rates. Secondly, we are living in an unprecedented time period where government actions have so overwhelmed fundamental economic analysis. In the market there is of course always uncertainty, but the one we are dealing with now is not reliably quantifiable in any model because again, its government event risk. Will US interest rates remain benign with much dependent on Fed action, will China raise rates and will other Asian nations continue to hike, will Spain and Italy become the next bailout targets, will there be a sovereign default/restructuring? Is 15 the right multiple when US government spending is rising to 25% of GDP and if not, will multiple compression offset a hoped for continued improvement in corporate earnings? Bottom line and to repeat, I have no idea where 2011 ends but I know for sure it won’t be as easy as many believe.
