Why earnings season will disappoint
Posted
Jul 08 2009, 03:34 PM
by
Anthony Mirhaydari
Rating:
There's nothing quite like earnings season. Three months of hope and fear condensed into the span of a few weeks as executives open the veil and let investors have a look. With Alcoa (AA) kicking things off Wednesday afternoon with an earnings beat (-26 cents per share against a -38 cent estimate), everyone is looking for signs the economy has truly begun the long march to recovery.
Unfortunately, with earnings expectations already pricing in a rather optimistic scenario, the results will likely disappoint.
While earnings estimates were slashed as the last two quarters rolled on, estimates for the second quarter have only decreased slightly since March. In fact, earnings expectations have actually increased slightly since bottoming back in May. In other words, stock analysts have become more confident not just in the economy's health, but in their own forecasts as well.
For Q408, the share-weighted earnings estimate for the S&P 500 dropped 33% from beginning of the quarter. For Q109, it dropped 28%. But for Q209, it has fallen just 1%.
According to Thomson Reuters, the current second-quarter earnings growth rate for the S&P 500 is at -35.5%. Back in May, it was at -36.2%. At the beginning of the quarter, it was at 31.7%. All ten sector groups are expected to post a drop in earnings, but the materials, energy, financials, and industrials sectors will be the hardest hit.
It's not just the analysts who are feeling good about the future: Executives have taken the negative-to-positive earnings pre-announcement ratio to very low levels. It was at 4.7 heading into the Q109 earnings season but has since dropped to just 1.5. The long-term average for the S&P 500 is 2.1.
I find it hard to believe, based on the economic data seen to date, that something spectacular happened over the last three months that justifies this kind of earnings optimism. Job losses have re-accelerated. Energy prices were elevated. Consumer confidence has soured. Home prices are still falling.
What's worse is that even with these inflated earnings expectations the market is still far from a bargain at current levels. The forward price-to-earnings ratio for the S&P 500 now stands at around 13.2x. Using historical data courtesy of Yale professor Robert Shiller, which goes all the way back to 1871, the average price-to-earnings ratio is 15x. In comparison, back at the March the ratio was just 11.7x.
Indeed when looking at past market bottoms, such as the October 1990 low when the forward multiple declined to 10.5x, I wouldn't be surprised if a retest of the March low was in order to properly account for the epic credit bubble that just burst.
Disclosure: The author does not own or control a position in any of the funds or companies mentioned.
Anthony Mirhaydari is a researcher for the Strategic Advantage investment newsletter. He can be contacted at anthony.mirhaydari@live.com. Feel free to comment below.
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