Is There a Method to the Badness?
By Vince Foster Aug 27, 2012 10:55 am
Not all market strategists are created equal.
The two most bearish on price, Goldman Sachs' David Kostin at 1250 and Morgan Stanley's Adam Parker at 1167, both have the S&P earning $100.00 vs. the average estimate of $101.30. The most bearish on earnings, Bank of Montreal's Brian Belski with a $98.50 estimate and Credit Suisse's Andrew Garthwaite with a $99.60 estimate, both have a 1425 price target, which is actually equal to the median of the survey.
With the average earnings estimate at $101.30 and the median at $101.00, I think it's safe to say that generally the strategists are in agreement with where the fundamentals are going to land. The difference is what price you are willing to pay.
What's interesting is the highest S&P 500 target from Weeden's Christopher Harvey at 1492 and the lowest target from Morgan Stanley's Adam Parker at 1167 -- ironically, both estimate earnings to come in at $100.00 per share. Harvey assigns the highest P/E at 14.9x multiple while Parker assigns the lowest only an 11.7x. What input in their models would constitute a 28% difference in price of the same earnings? It's likely in the estimate of the equity risk premium, which is the earnings yield spread over the risk-free rate or over corporate bond spreads. The lower the spread or premium, the higher the multiple and vice versa.
Ultimately, it doesn't matter what each strategist's model assigns the multiple to be; it only matters what price the market assigns. There are likely several variables that go into the calculation, but it is the equity risk premium that probably exhibits the most variance between strategists. That's because while sophisticated models can quantify discounted cash flows, the price of risk is not a function of math -- it's a function of sentiment. Wall Street strategists aren't miscalculating the math; they are misinterpreting the role of sentiment.
No positions in stocks mentioned.