Right now, the SP 500 is priced for sustainable earning power of
20.00 per quarter, or 80.00 annually at a 16.1 p/e multiple. That
multiple translates roughly to an assumption of a 4.0% inflation
rate. Investors have wearied of earnings estimates which have
proven too high consistently over the past year. On the plus side,
they are not buying into a continuation of the acceleration of the
inflation rate witnessed over the past year, and which could see
an interim peak of 5.2% yr / yr. for July. Inflation has been
dominated by a large run up of commodities, particularly oil,
gasoline, natural gas and raw foods. Since the broader commodites
composites have fallen by nearly 16% in recent weeks, one can
see the rationale for reduced concern over inflation.
The market is looking forward in conservative fashion, not yet
willing to buy into a rapid recovery in earnings over the next
6-9 months. Quarterly earning power had reached about 24.00
for the SP 500 by mid-2007. Net per share for Q 2 '08 may come
in around 19.40. The roughly 20% decline in quarterly net
primarily reflects a 95% hit to the financial sector income account,
which constituted nearly 25% of SP 500 eps at its peak. The
earnings forecasting errors by analysts following the financials have
been huge, as the industry has struggled to come to grips with
estimating its loan and securities losses during the recent debacle.
Overall, it would appear investors are not now factoringin a rapid
recovery of financial sector profitability, and are viewing
prospects for non -financial earnings conservatively in view of
concerns about when the economy may regain momentum seen as
the weakness in the stock market this year has been severe enough
to raise the question of whether investors are reducing longer term
expectations for earnings growth. It is hard to do much with this
issue so far, because the damage to earnings over the past year has
been heavily confined to one sector -- the financials.
The Fed has opted to keep short term interest rates low and to allow
monetary liquidity -- a key building block for economic and profits
recovery --to grow a little faster. These are encouraging early stage
developments that have to be seen in tandem with the temporary
benefits to the economy from the recent round of tax rebates, as
the latter may confuse the issue of the extent of Fed ease of liquidity
for a few more months.
Leading economic indicators that have started to soften again
coupled with still large credit quality spreads signify continuing
economic risk and low investor and trader confidence in the
environment. If the Fed continues to re-liquify the economy and
we see those credit quality spreads start to come in, we may have
something good to work with.
- Peter Richardson
- Retired chief investment officer and former NYSE firm partner with 50 plus years experience in field as analyst / economist, portfolio manager / trader, and CIO who has superb track record with multi $billion equities and fixed income portfolios. Advanced degrees, CFA. Having done much professional writing as a young guy, I now have a cryptic style. 40 years down on and around The Street confirms: CAVEAT EMPTOR IN SPADES !!!