Co-Written by Patrick Kirts
In part I we reviewed Standard and Poor’s earning estimates for 2009-10. They expect corporate earnings to continue with a slow climb throughout 2009, leading to a significant rebound in the trailing P/E in the fourth quarter, once 2008 losses are completely purged from the system. S & P’s scenario seems to assume that, once the 2008 losses are absorbed, a sort of muted business-as-usual will take over.
Indeed, the earnings recovery being predicted depends upon the absence of further large losses, particularly in the financial sector, which will not only avoid losses, but will continue to increase earnings into 2010. If only we could agree with this analysis. We see too many dangers ahead for the financial sector to put much stock in the rosy picture Standard and Poor’s is painting.
John Mauldin addresses the same issue in his April 10 Frontline Weekly newsletter article, “Is That Recovery We See?” He notes that estimates for S&P 500 EPS have been revised down continuously, from $92 in March 2007 to $54.82 on October 15, 2008, and finally to $14.88 this past week. He also notes that estimates for 2009 have undergone the same continuous revision. It would seem that Standard and Poor’s analysts have had a tendency toward excessive optimism in the face of the blackest news.
There is every indication that further sizable losses still await the financial system. Only parts of the credit bubble have been deflated, and we already have a housing market with so much oversupply that banks are keeping foreclosed homes off of the market in order not to depress prices further. The following graph from Credit Suisse (with a hat tip to Mauldin for reminding us of it) represents monthly mortgage resets scheduled for 2007-2016.
Now, keep in mind you can still trade, buy and sell, sell short and cover, whatever and still make some money. Our point is that when you open up the New York Times and a staff writer tells you the P/E is 12 or our President says the “profit-and-earning ratios” are cheap, understand the numbers behind it.