Earnings Season

Earnings season is upon us once again.  According to Marketwatch:  "Analysts surveyed by FactSet Research on average expect earnings at S&P 500 companies to be down 35.9% from the year-earlier quarter. Those surveyed by Thomson Financial expect earnings to be down 36.6% from the year earlier." 

In the fourth quarter of 2008, earnings were negative as a whole for the first time for the S&P 500.  On a bottom up basis, analysts are projecting that continuing earnings for Q1 2009 will come in at $13.00 a share up from -$0.11 in Q4 2008.  They are projecting as reported earnings to rebound to $8.75 up sharply from the stunning loss of -$23.16 for Q4.

Analysts missed the impact the recession would have on stocks.  Just 6 months ago, they forecast that Q4 continuing earnings for 2008 would be close to the all time record reached in Q3 lf 2007.  They forecast that Q1 2009 would break the record. 

A year ago, they also forecast a quick recovery from the drop in continuing earnings in Q4 2007.

Analysts are pricing in that the bottom is in for the recession.

Here is an update on Robert Shiller's S&P 500 graph.  Going back to 1881, the average P/E ratio using the trailing 10 years of real earnings has been 16.34. As of today, the current P/E ratio is 14.82.  Using the historical average, stocks are slightly undervalued.  However, the stock market has traded at much lower levels in the past.  In 1982 it reached 6.82 times 10 years earnings.  In the Great Depression it reached 5.56 and it reached 4.78 in 1920.

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A look at historical values on S&P 500 Earnings and Home Prices

Throughout the housing bubble, Robert Shiller's book, “Irrational Exuberance”, has served as my compass. In particular, his graph of U.S. home prices adjusted for inflation going back to 1890 was etched in my mind.

In his book, he talked about a home price index that was constructed in Amsterdam with over 300 years of data from 1628 to 1973. He writes “Real home prices did roughly double, but took nearly 350 years to do so…the annual real price increase was only 0.2%.” He released a graph , combining the Amsterdam data with data from Norway and the U.S., in a paper he published later.

Every month I update the S&P Case-Shiller Home Price Index and include what the CME Futures market is pricing in for prices in the near future. Here is a link to my most recent post on the Indexes.

Robert Shiller also had graphs of the S&P 500 going back to 1871. His website at http://www.irrationalexuberance.com/ has spreadsheets that get updated every so often. Here are two of his graphs that I updated with data through today's close.

Going back to 1881, the average P/E ratio using the trailing 10 years of real earnings has been 16.34. As of today, the current P/E ratio is 16.98. Whether or not the stock market is fairly valued right now is in great debate (as shown by the huge gyrations of the stock market in recent weeks). It really depends on what you think will happen to earnings and how severe the slowdown will become. Here is a graph showing the earnings for the S&P 500 going back 20 years.

The analysts have been caught off guard by the severity of the credit crunch. Back in April, analysts thought that 2008 Q2 earnings would be higher than the peak in 2007 Q3. Here is a graph from my April 2008 post. 2008 Q1 and Q2 earnings were substantially lower than forecasted. For the last year, analysts have constantly been surprised by earnings and have consistently overestimated earnings for the last 12 months. Last week's plunge was in part due to the fact the market was realizing that there will be a slowdown in earnings due to the credit crunch. The million dollar question is how much and how long the slowdown will be.

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Market is pricing in a quick recovery

The stock market is shrugging off massive writedowns by banks and brokerage firms. In the beginning of this month when UBS wrote off $19 billion in bad debt, the stock market had a strong rally. The stock market is pricing in that the worst is over. Here is a chart of the S&P 500’s earnings over the last 20 years. Earnings peaked in Q3 2007 and fell sharply as banks and brokerages took a lot of mark-downs. Over 20% of the S&P 500 companies have reported already. Earnings have been on average better than last quarter. The majority of banks and brokerages have already reported for this quarter, so it looks like Q1 2008 will rebound from the lows reached last quarter. In fact, according to the earnings estimates, the market is pricing in that Q2 2008 will be higher than the highs reached in Q3 2007. The market is then estimating that earnings will then regain their old form and continue accelerating higher at a rapid pace.This would be a very fast recovery. After the recession in 1990, it took 4 years for the market to surpass the highs reached before the recession. After the recession in 2001, it took the market 3.5 years to surpass the highs.

I think it is too early to call a bottom in the financial crisis. Housing prices are declining at an accelerating pace. Delinquencies and Foreclosures are also surging.

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