SENTIMENT UPDATE
Investor sentiment is now in the wildly bullish camp. The recent spat of “better than expected” earnings shifted market sentiment on a dime. The latest reading on the AAII% bulls shows a very high reading of 48. This has typically been a level associated with sharp stock market sell-offs.
The latest readings from the State Street Investor Confidence survey also show extreme signs of optimism”
“The index results strongly reflect increasing investor strategies designed with a view that the global recession will wane more rapidly than many had feared,” commented Froot. “Investors are now adding risk to their portfolios at an impressive rate, faster than we have seen in several years. In fact, this is the highest level the ICI Global index has reached since mid 2004. That is an impressive turnaround over last October, when the ICI Global reached its lowest-ever-recorded level of 82.1. Note the marked contrast with Consumer Confidence, which remains more focused on lagging unemployment.
“European confidence is much stronger this month, partly because of the concerns around the US seeming to abate, but also because the contagion that might have brought down their own financial institutions seems to be dissipating fast,” added O’Connell. “Asia has seen less variation in expected growth rates than the West and confidence there continues to strengthen, although there was never such an Asian wholesale fear of risk.
This is never a comfortable level of optimism for me. There is near universal agreement on the recovery trade. We’ve been bullish for weeks now, but the this side of the boat has gotten awfully crowded. I am a seller into today’s 2% move in the S&P. Although my target of S&P 1,000 is still 1% off I feel as though the risk/reward in this market has changed enough to warrant a 0% equity allocation. We’ll revisit the equity portion of our portfolio in the coming days and weeks.
Some comments on the bullish earnings optimism….
per ZeroHedge the Bloomberg terminal shows that Q1 2009 earnings were down 31.49% versus prior year and Q2 2009 earnings reports so far show earnings down 32.41% versus prior year. i.e. the Y-o-Y comparison is actually worse than last quarter. Revenues are even worse.
Per S&P analyst Howard Silverbatt’s spreadsheet, the Q1 2008 earnings were $16.62 so 31.49% down would be $11.38 (which would be a restatement above the $10.11 earnings actually reported in Q1 2009 due to changes in composition of the index e.g. elimination of GM). Q2 2008 earnings were 17.02 or 2.4% better than Q1 2008. If Q2 2009 earnings were expected to decline 16.5% which from $17.02 would be $14.22 or the bottom-up estimate. So far Q2 2009 earnings are down 32.41% (and if the issues remaining to report don’t move the % too much), then earnings in Q2 2009 would be about $11.50 or basically no improvement over Q1 2009 (up all of 1%). Historically, Q2 earnings usually seem to beat both Q1 and Q3 earnings.
I don’t know if the above calculation is correct due to all the restatements, but whatever the restated value is for operating earnings, it does appear that there is little improvement over Q1 2009 even with all the cost cutting and beating of earnings expectations. Revenues do not appear to be improving. After 197 issues reported sales were up only 1% versus Q1 and down -10% versus prior year.
As I wrote before, for the first group of stocks that reported, I calculated that about half the Q2 estimates were below actual Q1 and about half were higher with the average fairly close to Q1 2009. So the earnings beats do seem to be on rather low estimates. (I had figured most analyst estimates of individual company earnings would have been for improvement over Q1 2009).
The bottom up estimate for Q2 2009 is $14.22 and the top-down estimate is $11.05. What do earnings that are running 32% below last year mean for the restated S&P 500 earnings per share? How much of a difference do the restatements make? It appeared that both bottom-up and top-down estimates were raised by about $0.70 to $1.00 after GM’s elimination and other changes in S&P500 composition in May-June.
If anyone knows what the restated values of earnings are for the S&P 500 I would like to know. (i.e. on what earings level is the -31% and -32% being calculated?)
Unless my assumption are wrong, it appears to me that operating earnings will come in somewhere from $11.00 to $12.00 which is much closer to the top-down estimate of $11.05 than the bottom-up estimate of $14.22.
The 2010 estimates which are quoted in the media call for earnings of $74 per share (average of $18.50 per quarter or about a 60% increase over the current better than expected earnings). Those are the bottom-up estimates. Per Goldman Sachs latest call, they base their year-end S&P500 target at 1,060 based on 2010 earnings of 74 (which implies a 14.3 forward multiple).
Unless earnings improve much more dramatically than they did from the earnings trough in 2001-2004, the estimate appears to be quite optimistic. During the last recession earnings improved about 20% per year after things stabilized and finanicals contributed a large portion of the earnings growth. There seem to be more headwinds now. It seems reasonable that earnings might improve from maybe $47 to $48 this year to $57 to $58 next year. If earnings are $58 next year and maybe $70 in 2001, what is a fair value for the S&P 500 today and over the next month especially with a high level of uncertainty? Does valuation matter?
In my opinion, we’re in another one of these moments where the fundies are disconnected from reality. The market is riding on pure sentiment and momentum now. The underlying economic data is not nearly as good as CNBC and the MSM would have you believe.
I am very comfortable being on the sideline – even if the market shoots higher. I will likely jump in on the short side. In fact, a blow-off top would be a beautiful short set-up….
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