ARE EARNINGS ESTIMATES TOO HIGH?
This excellent piece (below) was on Bloomberg yesterday and cites another bearish note from Gluskin Sheff’s David Rosenberg. It notes that the analyst community now expects 35% earnings growth for 2010. They go on to show that this has only happened 6 times in 75 years and has been accompanied by 10% GDP growth each time. In essence, the implication is that this recovery is entirely different and is unlikely to rhyme with these other robust earnings recoveries. This is accurate, but terribly misleading in terms of timing. Have a look here and continue reading below:
What Rosenberg and Bloomberg fail to be more descriptive about is the timing of these high estimates. As we have long noted with our expectation ratio and earnings analysis (which has been spot on) the analysts have remained far too bearish for the last year. Where the above analysis goes wrong is in bunching 2010 estimates together as a whole as opposed to breaking them down by quarter.
A closer look at these estimates is vitally important in positioning your portfolio for the coming few quarters. In our 2010 investment outlook we said we were bearish about H2 2010 partly due to the potential for overly optimistic earnings analysis. If you look at current estimates analysts are calling for just 2.7% sequential growth in 2009 Q4 earnings. For 2010 Q1 they are calling for just 1.9% sequential growth. In a nutshell, they expect earnings to be in-line with the last few quarters (which I believe is utterly naive and lacking in any real analysis worthy of paid employment). These estimates are almost certainly low. Where things get interesting is in the later quarters of 2010.
In Q2 analysts are calling for a big jump in growth to 11.3% sequentially and 33% year over year. The same goes for Q3 where they are currently calling for 7% sequential growth and 25% year over year growth. These are big numbers. $19.72 & $20.62 in operating earnings per quarter is essentially what the S&P was doing back in 2006 & 2007 when the economy was at record low unemployment and the banks were cranking their high leveraged ponzi scheme on all cylinders. Can we realistically return to such levels so quickly? Call me a skeptic.
But timing is vital as I said above. In essence, the big estimate jump is backloaded in H2 and won’t become a major hurdle for corporations until this summer. Until then, the Expectation Ratio is dead on and continues to forecast an environment where analysts are far too pessimistic and stocks will likely drift higher as investors play catch-up. What will make these H2 estimates particularly interesting is their timing with potential rate hikes and the end of the government stimulus. The end of 2010 and beginning of 2011 has serious potential for downside surprise. Until then, I expect this market to frustrate and obliterate those who stubbornly short it.
Stay tuned early next week for our outlook on Q4 earnings reports.
Then according to you the stock market has indeed became a lagging indicator (as Rosenberg has recently been stating). While during the rally that followed the march lows the market was pricing AHEAD of time a recovering that never materialized (about 2% GDP growth in Q3 and probable 4% in Q4) now it is responding to whatever positive data arrives in the present with further strength ignoring the fact that the future is as uncertain and dark as it can possible be.
Also I find interesting that you posted recently the rhetorical question about the mysterious futures buyer. That question is key to current stock prices, but after dedicating one post to the subject you ignore it on further posts where you analyze markets as if they were evolving normally.
VCC Reply:
January 8th, 2010 at 5:35 AM
Right, 72% moves in a ten month span are perfectly normal. I sure hope the real economy doesn’t get in the way of the fairy tale: Ben And His Printer, how one man brought the world back from the abyss all thanks to the innovative idea of flooding the system with liquidity. In fact, no one has ever come up with this specific novelty before! And even if it’s been done before, I’m sure the results were something in the magnitude of a 72%, ten month market rally.
If this thing moves to 75,78,80,90%, maybe it won’t end up snapping like a rubber band. Unfortunately, we may not be able to ignore the real economy much longer even as this cat and mouse game with analysts continues. Til then, everyone’s a genius in this bull market.
TPC Reply:
January 8th, 2010 at 6:13 AM
I don’t think we’ll actually begin to see the actual strength/weakness in the real economy until H2. Right around the time when earnings estimates are way too optimistic. Could make for very interesting times.
TPC Reply:
January 8th, 2010 at 6:12 AM
I have never argued that the market is a great forward indicator.
call me a skeptic also. a country default or a state bailout or iran/isreal presents a buying oppurtunity…….all on the horizon.
don’t get stuck when they curb market sales.
You make the highly complex appear easily understandable. Thanks TPC. This is the sort of analysis that keeps me coming back.
TPC Reply:
January 8th, 2010 at 9:55 AM
Thanks SS. I have to dumb it down so I can understand it as well.
Assuming that analysts are overly optimistic in the back half of 2010 going into 2011, the real question then is when does the market start to perceive this and price it in? TPC – do you have any thoughts on lead time?
TPC Reply:
January 8th, 2010 at 10:55 AM
Tough call there. I don’t pretend to be able to forecast out more than a quarter with any real certainty so I am taking it quarter by quarter. This quarter is all clear to be long thru earnings season. We’ll revisit as earnings season get going and see how the market responds. I suspect we could see something like we saw last quarter where we rally into the beginning of earnings season and then sell-off mid way thru. I’ll keep you posted.
The 1st Q of 2010 looks okay for now. subsequent quarters have the potential to get more dicey.
Rather than attempt to use these guesstimates to make money in the market, I’d advise trading on the long side until the SPY breaks below the 50 day moving average on the daily chart and then convincingly is unable to rally back above it. Otherwise, just keep doing what is working which is buying the dips.
No forecast necessary.
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