Grading the Takehome: Bottoms, Earnings & Outlooks
We left a takehome test with y'all in yesterday's post on Bigg's Bottom vs the News. The key question being was his argument (and all the fairly sensible folk on CNBC) aligned with a whole slew of major scary news - that picked up four of our major themes btw. So what was your answer ?
We're going to sneak up on ours though our direction is pretty clear but before taking a look at
some charts and graphs (follow-on post) we'd like to ask what's driving the Street's optimisms. The answer turns out to be very clear - the Street and the analyst community is expecting a major uptick in earnings growth (something else we've been ranting on about as well) but we thought we'd do a compare & contrast between Fortune (who's reporting what it's been told) and Jim Jubak (who's analyzing what he sees).The differences are large, understandable in view of their different responsiblities and the gap tells us what's driving the market sentiment right now. If you check out Fortune's chart from Thompson the rationale is pretty clear. In fact if we thought those were the numbers then now would be a good time to reverse direction from our current position. Here's what Fortune had to say:
EXCERPTS
Earnings: Nowhere to go but up Poor results from the banking sector in the fourth quarter are likely to lead to the biggest drop in quarterly profits for large U.S. companies in six years. With 73% of the companies in the benchmark S&P 500 having reported results, overall fourth-quarter earnings are on track to fall 20.1% from a year ago, according to the latest figures from Thomson Financial. That's far worse than what had been expected as recently as Jan. 1, when analysts were predicting a drop of 9.4%. By the second half of 2008, year-over-year comparisons will get easier, since the third quarter and fourth quarter 2007 earnings were so miserable, said David Dropsey, senior research analyst at earnings tracker Thomson Financial. Dropsey said that if, as some analysts expect, banks are done writing off most of their exposure to bad mortgages by the middle of this year, earnings could rebound in the latter part of 2008. The S&P 500 should return to profit growth in the second quarter and that should usher in even higher levels of growth for the rest of the year as comparisons get easier and tech and energy sector earnings continue to show strong growth.
Which we'd like to contrast with Prof. Jubak's comments, which are more in line with our thinking:
You'll obviously have your own thoughts but to help them along, beside all the stories and analysis in the archives of course [:)] we'll put up some SP500 EPS estimate charts below for you to peruse. They're kinda detailed so you may want to skim them (& we won't got into long discussions) but we do suggest they're definitely worth running a reality check on.Tempted by China? 3 ways to cut risk The biggest risk to the stock market right now is the continued optimism of Wall Street analysts about corporate earnings. Wall Street still expects a quick end to the U.S. economic slowdown, recession, whatever. As of Jan. 31, Wall Street analysts were projecting a decline in first-quarter 2008 earnings and then a quick pickup in the second quarter, even for the embattled financial and consumer-discretionary sectors. (Consumer discretionary, as opposed to consumer staples, is the stuff that people can put off buying when they don't have the cash -- unlike, say, food.) For example, Wall Street is looking for a drop of about 15% in earnings for the consumer-discretionary stocks in the Standard & Poor's 500 Stock Index ($INX, news, msgs) from the fourth quarter of 2007 to the first quarter of 2008. But then, Wall Street is projecting a 35% jump in earnings in the second quarter (and a 2% drop in earnings in the third quarter). Financials are projected to show a 4% increase in the second quarter and a 3% increase in the third. The telecommunications sector is projected to show a 23% jump in the second quarter. Looking at those projections, it's easy to understand why consumer stocks, such as retailers, and financials have led the market in recent rallies. And it's also easy to see, unfortunately, how the market could drop again if those expectations for second-quarter earnings are dashed by a slowdown that doesn't turn around as quickly as Wall Street hopes.
The charts are built from S&P's earnings estimates which are available online on their site - though if you want to do historical comparisons you have to dload 'em and build up your own archives. The first chart shows '07 and '08 earnings and estimates along with growth rates from Dec31 and Feb5. Lots of little things to notice but two really worth contemplating. The annual growth rate in the revised seems to be because earnings dropped. And 2nd do the sector estimates hang together - especially when you have in mind our prior dissections of GDP components plus the various sector/industry news stores, e.g. the sudden rapid downward revision in tehcnology spending outlooks (as of yesterday morning).
The 2nd chart is the quarterly breakdown of actuals and estimates for '07 and '08 on the two dates. Again the same questions apply - given the state of the economy, the sector outlooks ofthe GDP components plus independent industry estimates do they make sense ? For example EPS for Consumer Discretionary is supposed to increase in absolute terms. Yet all of the last week's news tells us that consumer spending is about to slowdown sharply.
The final chart is QtQ% growth rates being forecast (Note: this is not our normal YoY% rates). Again take a close look and run a reality check on these numbers. The first chart, above the break, from Thompson was probably a YOY estimate which is consistent with these S&P numbers on that basis btw. Q407 to Q408 is 59% YOY for example if you run the calculations. Pretty good - astounding even. However, even on this QtQ basis the numbers look pretty good. One observation - notice the differences between the two Q1 estimates and the lack of difference in the 2nd half.What does that tell us ?
Now if you buy into those estimates now is clearly a long-term buying opportunity. If you think they're, shall we say, ill-grounded in realities as we do but think the musical chairs game of who believes what is accurate then there's a short-term trading opportunity. At least until the next slew of bad news comes wafting in. For example more debt write-offs, the widening of the credit problems beyond housing related instruments, lowered consumer spending as MEW dries up....well you get the idea.