About those U.S. earnings....
This market the most overvalued in 15 years
So here is the conventional view on the U. S. c orporate e arnings backdrop:
“Profits are booming. Not only have operating earnings come in far above expected, but the 14.5 per cent YoY pace is the strongest since the third quarter of 2011. And at $123 (the current four quarter S& P 500 earnings per share sum), we are back to a new peak!”
This is just a tad disingenuous. And I’ ll tell you why.
First, while it is true that earnings are at a new high, since the last peak nearly three years ago, the S&P 500 has soared 22 per cent while profits have risen just 7 per cent. At that time, one could reasonably have said the stock market was fairly valued.
But since then, with price returns tripling profits, the market now is supremely overvalued. In fact, the most overvalued in 15 years, and that includes the housing and credit bubble peak of 2007.
Second, I find it amazing as well as amusing that the cheerleaders are talking about how great earnings are when they are so woefully below the estimates that the consensus analyst community was forecasting years ago.
Indeed, let’s put the current $123 earnings per share (EPS) figure for the past four quarters into some muchneeded perspective.
In early 2014, the consensus for 2015 was $ 133 for operating earnings.
This was the estimate for two years ago and here we are in 2017 and earnings per share is still some $10 below that level... that we were supposed to have cleared ages ago!
In early 2015, the consensus for 2016 was $ 136. Incredible. Today we sit $ 13 south of that and the shills are going wild over how superb the earnings environment is. You can’t make this stuff up.
Then in early 2016, a year ago, the consensus forecast for 2017 was $ 138. And here we are at $123.
And in January of this year, the consensus for 2017 was $ 133, so if you notice, once- lofty expectations are receding once again. As of this month, this year’s EPS estimate has dipped further to $ 132 even as Q1 beat expectations.
To reiterate, the current consensus for S&P 500 earnings for this year of $ 132 is the same estimate provided two years ago. Imagine that. We have only managed to come back to where we were in early 2015 on this year’s earnings forecast. And yet, even though profit forecasts are no different now than they were back then, the stock market is up 17 per cent.
Moreover, as I said, we are now at $123 EPS for the past four quarters.
Consider that this was the 2015 projection by the analyst community published three years ago, and since that time, the S& P 500 has rocked and rolled by nearly 30 per cent. A surge in prices even though today’s level of earnings came two years later than the brilliant gurus had forecasted would happen.
And l ooking ahead to 2018, the bottom-up consensus started the year with a projection of just over $ 148 and today is down to $ 147. Not a big move, but forward estimates are now heading down, not up. This is vital because the stock market by its nature moves on shifting expectations, not by developments that are in the rear-view mirror and already fully discounted.
This is why, despite the massive bullishness constantly being espoused by the nattering nabobs on bubblevision, t he major averages have flat-lined now for nearly three months and the average and median S&P 500 stock actually is down fractionally — so beneath the veneer of a low-volatility headline index is a truly active two- way traded market where there are as many winners as there are losers.
The biggest loser actually are index funds and passive investing strategies — that bull market is clearly over. So how to invest? In an overvalued market, the opportunities are still there but less abundant than has been the case any other time in this nine-year run.
In an environment where profit forecasts are declining, it is critical to focus on companies with proven earnings visibility and low variability.
With there being no sign at all of economic re- acceleration and the Trump reflation theme proving to have been an illusion, it is time to shed exposure to stocks with above-average cyclical sensitivity.
And with various measures of consumer delinquency rates edging higher, and credit spreads overly tight, it is time to step up the overall quality of the portfolio and focus on strong balance sheets.
Finally, the bond market is telling a “lower for longer” story for anyone who wants to hear, and that means a pervasive focus on dividend yield and dividend growth characteristics.
Every i ndicator at my disposal is screaming “late cycle” and while timing recessions is no easy task, suffice it to say that this economic expansion i s now heading into its ninth year which makes it the third longest since the Civil War ( not just the Second World War).
In other words, we are somewhere between the seventh inning stretch and the bottom of the ninth.