David Rosenberg wrote today in his daily commentary that earnings expectations peaked with the stock market back in April. He observes that this is a common phenomenon – where stock prices do not follow earnings, but rather they more closely track earnings expectations.
When expected earnings are revised up by analysts, stocks rally – and when they are revised down, stocks sink. He cites several expected earnings inflection points of the past decade as turning points in the market as well (see page 6 of Breakfast with Dave for his full analysis).
This got me thinking – how can we find historical data of expected earnings? In a quick Google search I came up empty (though I’d appreciate any recs you may have!)
But I did get sidetracked into another interesting discourse on earnings cycles and secular bear market bottoms. Chad Brand, Founder and President of Peridot Capital Management, wrote a VERY timely piece on March 6, 2009 denouncing the “trough P/E multiple on trough earnings myth.”
Doug Kass, a hedge fund manager dedicated to short selling and frequent guest on CNBC, made a call on the air Monday that the S&P 500 could make its lows for the year this week. A bold call indeed, given that Doug is a short seller and has been correctly bearish on the economy’s prospects for a long time. His reasoning is mostly based on extreme pessimism (not unlike in November when we made a short-term low) and low valuations.
Other commentators debate the valuation point. CNBC’s own Bob Pisani made the case that assigning a 7 or 8 P/E ratio (a typical number at bear market bottoms) to this year’s depressed earnings level forecast (currently around $50 for the S&P 500) is reasonable. Pisani concluded that unless you think that earnings in 2009 will be substantially above $50 (which is very unlikely), the market is not cheap because 7 or 8 times $50 is 350-400 on the S&P 500 index, versus today’s sub-700 level.
When Kass was on the air on Monday he rightly suggested that putting a trough P/E on trough earnings is not appropriate, but market commentators continue to insist that is where the market needs to go before a cyclical bottom can be put in.
Talk about a spot-on call! Kass and Brand couldn’t have been any more on target with their timing, or their valuations for the S&P 500!
We’ve talked a lot about target valuations for the bear market at the upcoming secular cycle bottom. And we, like Brand, have also followed the valuation work of John Hussman – who believes the S&P 500 is overvalued by about 40%.
So using a little “back of the envelope” valuation measures – if we use $90 as the peak earnings number, and toss a 7-8 multiple on it, we’d be looking for 630-720 on the S&P. Basically a re-visitation of the March 2009 lows.
But that’s IF the previous playbook of post-WWII recessions is the correct one. I actually don’t think it is.
If we use the Great Depression as an example, we’d expect a 90% peak to trough haircut in stocks. If we use Japan as our yardstick, then we’d expect an 80% trim (and counting).
Therein lies the rub. If this is just another bad recession, then an S&P in the 600’s or 700’s could be a screaming buy. If this is worse, though, then those price points could ultimately prove to be “value traps”.
One aspect that spooks me here is the demographic angle. I’m currently reading The Great Depression Ahead: How to Prosper in the Debt Crisis of 2010 – 2012, by Harry S. Dent, who derives his economic forecasts primarily from demographic data.
According to Dent, Japan’s peak spenders (folks in their 40’s and 50’s) have been in decline since 1990 – approximately when their stock market peaked. This demo in the US peaked very recently – in the past few years. We are now swimming against the demographic tide, rather than with it, for the first time in recent memory. So it may indeed be different this time – different in a bad way!