Expect More Misery in Earnings

If I had to guess, I’d say the economy is in a recession right now. That’s not exactly a brilliant insight. It seems pretty obvious just by looking at equity prices.

Next week, the government will deliver its first report on Q3 GDP and I’m expecting a dismal number. Or rather, whenever we get the final report on Q3 GDP, I expect a dismal number. The problem with GDP reports is that they’re subject to constant revising, so it takes a long time, several years in fact, to find out how well the economy is really doing.

A better measure is the unemployment rate. This, too, is imperfect, but it’s good at giving us a look at direction. And that direction has been nothing but down recently. The jobless rate reached 4.4% last March and got to 6.1% in September. If the rate gets to 8%, and we’re already nearly halfway there, that would be a 25-year high. I think 8% is very possible.

We’ll also get a good look at how the economy did in the third-quarter from corporate earnings. This week, one third of the companies in the S&P 500 report. Earnings for the S&P 500 will probably drop about 10% for the third quarter. There’s a lot of guesswork involved but the earnings declines will most likely continue through the first half of 2009.

The Wall Street Journal notes:

Top-down estimates of 2009 earnings range anywhere from $87 a share down to $60 a share. An average of a handful of such forecasts is that earnings will fall roughly 10% next year to about $73 a share. Thus, Wall Street's consensus may be overestimating earnings by at least 25%. Still, that means the S&P is trading at about 13 times forward earnings -- also a relative bargain.

That forecast also assumes earnings will bottom early next year, resulting in at least a 10-quarter earnings decline of 30% from the 2007 peak to their trough. That would roughly match the 1989-91 earnings downturn, which also started with financials, lasted 10 quarters and shaved about 24% off earnings.

The problem with looking at this market isn’t valuations. Equity prices were never in a bubble. The problem was that fundamentals cracked, and we don’t yet know where the bottom is.

Comments

[MSmailbox:]

What about a stock like POT, where there was a bubble and it popped? Fundamentals seem sturdy enough. I'm not contesting your assessment of the general market, but what of the exceptions? Will this type of market value a company with strong earnings, good management and a host of other positives?

2008 Oct 21 11:07 AM