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The S&P 500, DJIA, and NASDAQ are all up about 40% from their lows on March 9th.  Why?  Has the economy (and earnings) rebounded that sharply?  Or were the March lows an aberration?  It’s been a while since I talked about the stock market or the larger economic picture, so it’s time to revisit those themes.

First, the economy.  From the data to date, it appears that the broad US economy is shrinking less rapidly than it was just a few months ago – but it’s still shrinking.  The GDP shrank at a 6.3% rate in the 4th quarter of 2008, and it shrank at a 6.1% rate in the 1st quarter of 2009.  These are the revised (as of May 29th) numbers straight from the BEA here.

Passenger: “The GDP is better than it was before Captain – can we start the party?”

Captain: “Ummm, let me think….  The ship is still sinking….  But it’s sinking at a slightly slower rate.  Re-arrange the deck chairs again, maybe that will help.  Party on dude!”

Ok, so the economy isn’t growing – what’s behind the 40% rise in stocks?  Could it be earnings?  Maybe companies have laid off enough workers, and streamlined operations enough so that their profits are 40% higher than last quarter?  Let’s look at the numbers….

With 99.43% of the Q1 2009 earnings reported, the total earnings of the S&P 500 adds up to $7.61.  That’s certainly a lot better than the negative $23.25 the S&P 500 earned during Q4 2008!  Keep in mind that Q4 was the first time ever for “negative earnings” for the S&P 500.   And another word for “negative earnings” is “losses”.  Or “deficit”.  As in “the US Government has $1.85 trillion in negative earnings for fiscal year 2009.”

Anyway, $7.61 in earnings must be a good thing if that has caused the stock market to surge about 40% in the past 3 months right?  According to Standard and Poors latest spreadsheet, no.   Except for last quarter’s losses, As Reported earnings haven’t been this low since Q4 of 2002.  And the Operating Earnings (currently $10.15) haven’t been this low since Q4 of 2001.

Ok, so actual earnings aren’t driving the market higher – what if the earnings are low, but beating the estimated earnings?  In other words, what if company earnings suck, but they suck less than investors expected them to suck?  Sorry Charlie, according to Howard Silverblatt, S&P Senior Index Analyst, “actuals are -24.3% off estimates, and -43.5% behind last year”.

Of course, Howard goes on to say that the “Operating vs As Reported (top down vs bottom up) varriance enormus; out of the woods or the Island has moved.”  I’m not sure what it means when the Senior Index Analyst at Standard and Poors can’t spell “variance” or “enormous”, but it can’t be A Good Thing.

In the same note, Howard also says “189 issues beat est, but only 87 beat last years earnings; 290 missed with 72 beating last years EPS” which translates (seriously) to “189 out of the 500 companies in the S&P 500 beat their earnings estimates.”  189 out of 500 is about 38% – that means that 62% of the S&P 500 MISSED their earnings estimates.  And yet the stock market is 40% higher.

Ok, so maybe the forward PE ratio is finally coming down to reasonable levels?  It was at a record 60 to 1 at the end of Q4, it must be better now….  Or at least when we look at the estimates for the rest of the year….  Right?

Wrong.  The current PE ratio for the S&P 500 is 114.77, another record high.  And it gets even worse when you look ahead.  Here are the current estimated PE ratios for the S&P 500 for the rest of 2009.

• Q1 – 132.22
• Q2 – 3513.31 !
• Q3 – Negative 301.52 (first negative annual PE in history)
• Q4 – 33.46

To sum it up, I see no reason for the current level of stocks.  Zero.  The S&P 500 index (currently at 944.74) is too high relative to earnings – and in the long run, stock prices are based on earnings.  This minibull may continue for awhile, but prices WILL eventually adjust to the low earnings.  And from where I sit, that means stocks will drop back down to at least the March low sometime this year.

The only possible way I can see stocks continue to rise is inflation.  Specifically, inflation caused by the enormous amount of money the Fed is printing out of thin air and injecting into the money supply.  In that case, stocks can – and will – go higher.  But the actual price increase will be close to zero when adjusted for inflation.  And if you want to maintain your purchasing power, gold and silver (in your physical possession, not an ETF!) are, in my humble opinion, much better inflation hedges than stocks.

I could go on and on about how Geithner, Helicopter Ben Bernanke, a willing Congress anxious to be seen as “doing something”, and Obama are making the mess worse – just as Greenspan, Bernanke, Bush, and a willing Congress created the problem – but that’s another story for another day.

gk

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I’m not the only one saying the S&P 500 needs to drop.  An article at My Budget 360 has some good information and analysis about P/E ratios and why they matter.

Some are arguing that the fair value of the S&P 500 should be somewhere around 440 if we take a multiple of 15 which would be in line with historical P/E ratios.  That is a stunning number but makes sense.  That means the S&P would need to fall an additional 330 points, a drop of 42% from where we are currently at.  That is hard to imagine yet the math points us in that direction.

Check out the entire story – it’s good stuff.

gk

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It’s been about a week since I posted an updated earnings report for the S&P 500, and there are a few new items.

By far the biggest item is that S&P is now recognizing that Q4 earnings – well, there aren’t any.  This will be the first quarter ever where the 500 companies (which make up the S&P 500) total earnings add up to a negative number.  Normal people call this a loss, but brilliant economists say “negative earnings” as a euphemism.  I guess they think it sounds better than saying losses.

The latest update from S&P (link opens an Excel spreadsheet) has this in the notes at the top:  As Reported earnings are negative for the quarter, with or without Financials. Previously, the financial sector was blamed for the losses, but they’ve finally realized that most everyone’s earnings are in the tank, and that aggregate earnings are non-existent – even when you exclude the financial sector.

They also say House cleaning should be massive enough to keep first half of ‘09 clean of ‘items’, after that it depends on the economy.

The problem is that they’ve been saying this since Q4 of 2007.  Every time earnings are lower than expected the analysts have said “this is the kitchen sink quarter” meaning that they think the companies have cleaned house and reported every possible thing that could be bad.  And they’ve been wrong every quarter.

They’ve been wrong because the companies themselves don’t know the extent of their losses, because they don’t know how much more they’ll need to write down because the value of their assets (mainly various derivatives of mortgages) are still declining.

Another note that should give you pause is With 84.8% of the market value and 390 issues reported, operating earnings are -62% below Q4,’07.   So even excluding everything that they claim are one time losses (which show up in the as reported earnings) operating earnings are less than half of what they were the same time last year.

On Dec 31st, 2007, the S&P 500 closed at 1468.  Here’s a fun game to enable you to calculate an equivalent price (based on operating earnings) today.  Simply adjust the 1468 close last year by subtracting 62%.   1468 – (1468 x .62) = 557.97. It isn’t difficult.  Based on this, the S&P 500 should be in the neighborhood of 500 to 600 right now, but yet it closed Friday at 826.

In other words, the S&P 500 index still needs to drop another 260 points (about 30%) from the current level to be priced the same as last year.  I thought the indexes were too high last year, and I think they’re still too high.  We are not at the bottom of this bear market.

Look at the spreadsheet in the link above.  Look at cell H35 where it shows the current trailing P/E ratio.  It’s freaking 30!  Waaay too high.  Either earnings need to double or stock prices need to fall.  Which do you think is more likely in today’s environment?  I think stock prices will fall.  I don’t know when it will happen – but it will happen.

At least S&P has FINALLY lowered their insane $81 estimate for 2009 earnings – dropping it all the way to $32.  Even that’s a jump from the (estimated) $27 the S&P 500 earned on 08.  Just another reason that I think the market still has a ways to drop.

More fun with math – try calculating a P/E ratio for the Q4 earnings alone.  The math is really simple.  Take the closing price on December 31st and divide it by the as reported earnings.  Here’s the formula:  903/-10.44.   Don’t forget the minus sign!

What’s that you say?  You say it shows a negative number?  Weird ain’t it.  It’s never happened before.  If you want to play with the spreadsheet a bit, try this.  Divide the result you just got (-86.52) by 4.  That will give you a P/E ratio closer to numbers that you’re used to seeing, except it’s a negative number of course. -21.63 to be exact.  That’s the current (instant?) P/E ratio of the S&P 500.

Now try it for historic prices and earnings.  When I do this with the S&P spreadsheet going back to 1988, I get a wide range of numbers, with the lowest being 10.65 (in Q3 1988) and the highest being 73.32 in Q4 of 2002, and an average of 23.17.

The current number (-21.63) blows away the previous low.  There are no earnings right now – only losses.

I want to quote another comment from the spreadsheet: As Reported short-term P/E (column H) higher than the bleachers at Yankee Stadium.  And Talk of second half ‘turning the corner’ now second half / early Y2KX (2010)

In other words, prices are too high on a value basis right now, and the estimates for the economy to bottom out have been pushed off into late this year or next year.  They say the stock market is looking ahead 6 to 8 months.  Those who were hoping for a rebound in Q3 are going to be disappointed.

gk

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I was just looking up the latest earnings estimates for the S&P 500 on the Standard and Poors website, (link will open an Excel spreadsheet) and I noticed a dramatic change from a week ago.

In the “Operating earnings per share” section near the top, where Standard and Poors normally lists the estimated earnings for the S&P 500, there’s this note: “This series is under review should be posted soon.”

Are they finally going to lower the insane estimate of $81 for the 2009 earnings?  I’m guessing so.  There are also a few interesting notes at the very top of the spreadsheet.  Here’s a sample:

With 25.36% of the market value and 93 issues reported, actuals compute to a negative $-1.16 for operating (est $+3.02); -$3.18 for As Reported

Translation – with over 25% of the S&P 500 having reported 4th quarter earnings, the total earnings reported so far are negative $3.18!  Go ahead, try computing a price earnings ratio with negative earnings.  Unless you know something about math that no one else does, you’ll get a negative P/E ratio.  I’ve never heard of that with the S&P 500 before.  (The DOW 30 had a negative PE ratio for awhile last year though.)

Operating set for the 6th quarter of negative growth, a new record (5 in Q4,’00-Q4, and Q4, 90-Q4,’91) (I think that speaks for itself.)

Financials set for their 5th consecutive quarter of negative EPS, also a record; 5 Qs -$97B vs. prior 5Qs $+263B, $-360B turnaround.

Translation – financial institutions have now had a record 5 straight quarters of cumulative losses.  During the last 5 quarters, financial institutions cumulative earnings are negative $97 billion.  That’s $360 billion less than the 5 previous quarters combined.

Operating EPS coming in 8% lower than top-down estimate, Staples coming in slightly better than expected, continued large Financial loss.

Translation – we were wrong!  These companies suck!  Despite our estimates, they really aren’t making any money!  We’re idiots!  (Just kidding!)

I’m sticking to my 2009 estimate of earnings for the S&P 500 to be in the $40 to $50 range.  We’ll see how long it takes Standard and Poors to post new estimates that are more in line with reality.  And mark my words – the stock market will drop when they do release new estimates, because everyone will be walking around saying “How could we have been so freaking far off?”  While others simply say “duh!”

gk

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