Double Digit Earnings Growth Is OFFICIALLY Over

Discussion in 'Trading' started by ByLoSellHi, Feb 8, 2007.

  1. Earnings Slowdown

    For the 351 members of the S&P 500 that reported fourth- quarter results, average earnings growth was 9.2 percent, according to data compiled by Bloomberg.

    If earnings expansion remained at that level, it would end a 13-quarter streak of profit growth above 10 percent, which matched the longest such streak since 1950, according to Thomson Financial.

    So, if you buy in here, you're paying extremely high prices for shares based on their last 13 quarters' worth of performance.

    You'd better be confident their earnings won't decelerate.
  2. Bond yield spreads and stock earnings growth has narrowed.
  3. Your premise is right, but the conclusion is wrong. Actually, you are paying very low prices. The S&P 500 forward P/E ratio is at around 16, the lowest in 10 years or so.

    Also, the differential between the S&P 500 forward earnings yield and the 10yr bond yield is a positive 1.5%, forecasting an "up" year for the stock market using the so-called Fed model, which has been right in the last 7 years in a row. In fact, this model suggests that the stock market is undervalued by about 30% compared to bond market.

    Here is yet another model (of my own derivation):

    S&P fair value = S&P forward earnings / (10yr Bond Yield * RiskAdjustmentFactor - S&P earnings growth rate)

    Let's plug in the values:
    S&P forward earnings = $90.38
    10yr Bond Yield = 4.73%
    S&P earnings grow rate = 9.2%
    RiskAdjustmentFactor = stock market volatility / bond market volatility = 2.94 (reference)

    This gives us:
    S&P fair value = 90.38 / (0.0473 * 2.94 - 0.092) = 1920

    which means that the stock market is undervalued by about 32%. Notice that this figure is very close to the "Fed Model" figure.

    Now, it's true that if the profit growth decelerates, it will change everything. For example, if it drops from the current 9.2% to, say, 6%, the last formula would give us the fair value of S&P 500 of 1143, assuming that everything else stays the same.
  4. Nonlinear, but we all know that forward P/E analysis (i.e. trying to project future P/E ratios) is fraught with risk. Benjamin Graham taught us this, and history has proven him right time and time again.

    Here is a good article discussing how low quality equities, which comprise a disproportionately high % of the S&P 500, and that have enjoyed much higher than 'normal' earnings lately, skew the P/E ration in a manner that makes its 'offical' current P/E highly misleading, as well (because of the high earnings of these low quality companies in the recent past, and because of what I've said - those earnings are cyclical and likely to decline over the next several quarters, if not longer):

    It’s been a mixed few weeks for the major US indices. Even after the recent turmoil, the Dow Jones Industrial Average is still up around 2% since the start of the year, while the S&P 500 is slightly down. The Nasdaq Composite has slumped to its lowest level in 13 months after a string of poor earnings reports from technology companies.

    The relative performances of the Dow and the Nasdaq are understandable. After all, in these troubled times, investors are choosing to put their money into sturdy old-economy companies and avoiding risky tech stocks. True, some of those Dow stalwarts look less than sound themselves – take a bow Ford and GM – but who ever said that markets were rational? However, the S&P’s weakness has seen many commentators arguing that it now looks outstandingly cheap. The index trades on a forward p/e ratio of around 14, which is far too low at a time when non-tech earnings growth remains extremely strong, say the bulls.

    Dig deeper, though, and you find reasons why it may not be such a bargain. “We think that such reasoning is incorrect, because it ignores the cyclicality of earnings and inflation,” says Richard Bernstein of Merrill Lynch. He calculates that because lower-quality, more cyclical stocks make up a larger proportion of the index than they have historically, the cyclicality of the S&P 500’s earnings is at an all-time high. This means that valuing the S&P on the basis that the recent strong earnings performances will continue is suspect, because of the risk of a cyclical earnings downturn. A low forward p/e could be justified by this earnings uncertainty.

    In addition, Bernstein believes that higher inflation will persist longer than many expect and that “investors do not seem to realise that there is an inverse trade-off between p/e ratios and inflation”. His inflation versus p/e model suggests that, far from being cheap, the S&P is still 5%-10% overvalued.

    Bernstein also looks at several other cyclical markets around the world and finds that while their current p/e ratios are low, one-year forward p/e ratios are rising. In other words, analysts in these markets think that earnings already have peaked and expect a downturn. Maybe the S&P will be different – or maybe US analysts are just being over-optimistic.
  5. john12


    thats ridiculous. profit margins have been at the highest rates in 50 years and have no were to go but down big. i've read several articles saying using normal profit margins since 1990(which are in itself extremely high compared to the last 100 years) the market is trading at 25 times earnings. remember we're at the longest pt in history without a 10% correction or a 2% daily pullback. the vix is 10 theres no fear for 10 miles around and many sentiment indcators are wildy bullish. again its been like this for a long time and can stay like this for a even longer period of time. but its very possible when the shakeout comes to the downside it will be very fast and violent as we've stayed in comatose no fear territory for such a long period of time any big drop could set a panic to think we've started another long leg up after already being in the 3rd longest bull in history standing at 4 1/2 years is a very risky thought. not to mention i've yet to see anyone on tv in months even utter a thought we can fall. the bulls are in charge till further notice. for instance i'd bet my house the futures won't be down more than 3 or so pts in the am. its that sure a thing we don't drop
  6. Who cares about earnings? The bull run is fueled mainly by excess liquidity, global interest rates are still very low (take a look at Japan!!!).

    The market can stay irrational longer than you can stay solvent, most shorts will go bust before we get a meaningful correction.
  7. ha ha More BS from bloomberg another cruddy publication

    one only need to look at the PE ratios to see stocks arent overvalued