Another Round of Earnings Disappointments

So, how did the US market respond to this data? The Dow was up 258 (almost 3%) and the NASDAQ up a sprightly 3.5%. Nothing to worry about.

However, earnings, as you might expect, aren’t doing all that well. For the last year I’ve been highlighting how earnings estimates are dropping for the S&P 500 as analysts try to catch up with the reality on the ground. They’re still behind the curve.

Let's look at their estimates for earnings in 2008. They started at $92 in early 2007 and are now down to $48. This chart won’t inspire confidence in stock analysts.


Click to enlarge

On a trailing 1-year basis, that puts the Price to Earnings Ratio (P/E) at over 19 as of today's close at 925, which doesn’t make the market cheap. But last year's earnings are history. What about 2009? Again, the analysts are in a race to find the bottom.


Click to enlarge

The current projections are for $42.26 for 2009. That makes the forward P/E 22. That doesn't look like value at all, when the historical average is closer to 15.

Bulls would argue that the market is forward-looking and that all the bad news has been priced into the market. I would counter that the market has thus far done a bad job of pricing in bad news, given the fall of the markets last year in the face of a recession. As I repeat incessantly, the US stock market falls an average of 43% during recessions. The stock market was not discounting a recession last January or even in May - even after a very serious financial crisis.

But how bad can it get? By now, analysts must surely have lowered their estimates to more realistic numbers. Shouldn't we start to price in the recovery from here? Well, no. Not if you look at the last recession.

In 2001, as-reported earnings were $24.67. Operating earnings in 2002 were $27.57. Does anyone think the current recession will be milder or shorter than the last one?

And it gets worse. Core earnings, which take into account pension and other under-reported liabilities, were less than $16 in 2001, and so P/E on a core-earnings basis topped out at 71, and on an as-reported basis were as high as 46!

Of course, after that the stock market went on a tear, almost doubling over the next 5 years. And today the market seems to be suggesting that many people are afraid to miss out on the fun of the next bull market run.

A Bear Closes His Short Fund

I had a long conversation today with Minyanville Professor Bill Fleckenstein, who runs a short-only hedge fund and has done so for many years. He’s one of the more outspoken and well-known bears, and he told me that he’s closing his short fund - shutting it down and sending all the money back.

"Right now, my list of stocks that I want to be long is longer than the list I want to short,” Fleckenstein says. In the current environment, he wants the ability to go long as well as short. For those of you who are long the market, that is probably as good an indicator as any that we are closer to the bottom than we are from the future top!

Interestingly, we agreed on a possible scenario for the first half of the year. We both see a very tradable rally going into spring. Then, when we get even more earnings disappointments at the end of the first quarter and warnings at the end of the second quarter, we could see another test of the November 20th lows. Earnings disappointments are the catalyst for protracted bear markets. But the wild card is the coming economic stimulus package. We’ve never been in a situation like this.

While I’m negative on the stock market (and markets around the world) in general, there are some stocks that are now at reasonable values. When you can find a stock with a P/E ratio lower than its dividend and reasonably well protected, I can't argue with a long-term investor buying that stock. 6% dividends can cover a lot of market sins at these levels. (Don't ask for stock recommendations: I don't analyze stocks. My business is analyzing the economy and money managers - a man has to know his limitations.)

The market seems to be thinking the economy will be coming out of recession in the 3rd quarter of 2009, hence the rally. I think that’s optimistic. As the research above suggests, this could be a longer and deeper recession than anyone younger than 50 can possibly remember.