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IT’S EARNINGS THAT MATTER

Following up on our previous note about the importance of corporate earnings and the potential peak in the earnings cycle – David Rosenberg had some pertinent facts from this morning’s note:

“It must be extremely frustrating for the bulls to see the market down 12% from
the April peak even with 12-month trailing EPS rising 18% since then.  So what’s changed for the worse?

The answer is analyst earnings revisions.  The Thomson IBES 12-month forward
earnings estimates have been trimmed more than 7%, to $87.89 from $94.79
back in April.  Come to think of it, the peak in earnings forecasts coincided with
the peak in the market.

And guess what?  The forecast peak in the last cycle was in October 2007, again
right when the S&P 500 was hitting its highs.  Before that, earnings estimates
were starting to get cut in August 2000, just ahead of the peak in the market.   If you are just watching the earnings themselves, on average they are off six
months from the time the stock market rolls off the peak.  Earnings estimates
seem to be a perfectly good timing device.

The same holds true at bottoms.  Forward estimates hit their trough in March
2009 right at the same time the market bounced off the lows.  If you waited for
the actual earnings to revive, which they did in November 2009, you would have
missed eight months of 65% gains in the S&P 500.

Go back to the cycle before that one and you will see that earnings forecasts
only began to rise in January 2003 — right when the equity market was carving
out a bottom.  If you decided to jump in when actual earnings bottomed, which
was much earlier at December 2001, you would have been clocked by the huge
correction that occurred just under a year later.”

This could very well be the most important juncture in the cycle.  If earnings have peaked and margin expansion has been maxed out by corporate cost cutting and a lack of revenue growth then there’s a high potential for excessive optimism should the earnings begin to disappoint to the downside.

Source: Gluskin Sheff

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