For the first time since the bear market began, an earnings season has given a boost to the stock market. Although much of this is to be attributed to the “complicated” bank earnings, it is a positive development. The primary driver of the better stock response has been the sharp reduction in analyst’s estimates and the nearly complete lack of real revisions heading into the bank earnings. I can’t think of too many banks besides Morgan Stanley that actually missed their earnings estimates. Whether this is due to better results or analyst ignorance is up for debate, but as of now I am leaning towards the latter.
Thus far, 80% of the S&P 500 has reported and the bottom line figures have been substantially better than expected. Roughly 50% of the index has outperformed analysts expectations. Only 90 of the companies have reported better revenue growth year over year – a clear sign that cost cutting is the primary driver of better bottom line growth (as opposed to true revenue growth). This is important to note because revenue growth is a much better gauge of economic strength. Companies can only cut so many costs. At some point they need organic revenue growth to drive earnings.
Estimates have declined further in the last week to $58 and this sharp decline in estimates has resulted in a far better expectation ratio. My proprietary indicator has shown drastic improvement (for those looking for a primer on the ER please see here). Much of this improvement is due to the better than expected results from the banks so the data going ahead will be much more useful. Nonetheless, this is a very positive long-term sign. Remember, the ER is a LONG-TERM indicator and the improvement in the ER shows that earnings and expectations are coming much more in-line with one another. This is a very positive development as we’ve seen this from quarters results.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
Yes it’s understandable why the market reacts positively when a company beat expectations. The question is why are the valuing companies so highly such that we’re at such high valuations of P/E no matter how you figure them. We’re in the middle of a tremendous debt deflationary contraction and the worse downturn since the GD, by most objective measures. So how can all that be “discounted” at 900 on the SP500?
I guess the investing public has been so numbed to high P/Es by the tech bubble and the debt bubble, and trained to accept that valuation, that they just can’t keep their hands off anything with a P/E less than 15, much less 10. And a whole lot higher too right now. Are we doomed to never see really attractive valuations again? Or will it take another 7 years or more of a grinding secular bear to get us there?
I guess that’s my take on it now. Only when we go through another cyclical bull or two (of decreasing size I’d bet), and people have lost money on today’s buys, will the value investing perspective come back to the fore.
Here’s another thought. What if the current optimism leads analysts to once again start pumping up their estimates for Q3 (I doubt they’d do it for Q2) and then we start missing on those when this great recovery doesn’t really pan out (which is where we’re going IMO)?
Maybe that will be the next big leg down after one of the smallest, shortest “bulls” on record. Thoughts TPC?
Don’t be shocked if that happens, but as of now they’re still cutting estimates. Remember Onlooker, the market doesn’t go down in a straight line. As you’ve mentioned, it would be very rare for the market to trough at such a high PE. But that doesn’t mean it can’t trough in 2011 or 2012….I was actually bullish in my 2009 stock market predictions. Not because I believed the economy was going to genuinely rebound, but because I believe we came down too far too fast and it could take years for the market to digest the negativity of the de-leveraging that is actually occurring. We’re seeing the false dawn in housing that I called for and as you’ve said dozens of times the real resets begin NEXT year. Don’t be shocked if this economy retrenches hard in Q3 – Q1 of 09 and 2010….What we’re definitely not getting is a sharp recovery….
Thanks TPC. I appreciate the feedback. I’m still learning the psychology and dynamics of the market. And sorry for harping on the foreclosure wave coming! I gotta vent somewhere. 🙂
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