S&P 500: There Is No P/E (Part II)

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.

Disclosure: No positions.

Comments

[Larry House:]

Good points.

Apr 22 09:54 AM

[History Buf...:]

Trailing earnings are what most people look at. It's always dicey trying to estimate future earnings, which is why a certain amount of stock picking is essentially legalized gambling.

That's my response to people who try and tell me how "cheap" the market is now. Believe me, it could get a lot cheaper.

Apr 22 10:59 AM

[Jasper M:]

Excellent article.
I am reminded of a prediction by Robert Prechter, that the current recession would first be denied, then retroactively acknowledged but downplayed, then its severity gradually, grudgingly admitted to. We seem to be precisely on that glide-path.
Like most prognostication, S&P et al's default assumptions are based on some sort of continuation of the statues quo. From there, they introduce minimalist corrections. to account for what is under their nose, without unduly disturbing what they want to see. And it frequently works. But not at the big turns - the Big Turns are made Big buy the fact that the Big Players are Wrong.
And there is no player bigger than the government . . .

Apr 22 01:23 PM

[drbob66:]

There's a graph of historical corporate earnings through various downcycles here:

www.ritholtz.com/blog/.../

Apr 22 02:30 PM

[THofler:]

Using an agregate earnings number to create a P/E value for the S&P500 is nonsense.

Is the S&P500 a single company with 500 divisions? Or is it essentially a mutual fund with a portfolio of 500 components?

If it is the former, then horrendous losses at a few divisions can send the "company's" stock to zero. If it is the latter, then you can send the stock value of a few components to zero and experience only modest declines in the portfolio.

To be fair, Mr. Munson didn't dream this up. The geniuses at S&P have been listing these numbers for a long time. And they may have some value as part of a historical comparison. (Did anyone not know that our economy was at an extreme level of stress?) But don't be deluded into thinking that an S&P500 P/E number bears any reasonable connection to sensible P/E values for an individual company.

Apr 22 02:41 PM

[buckbuck:]

Individual companies or not........450 of the 500 are loosing money.......so what does that mean.........maybe.......

Apr 22 07:58 PM

[buckbuck:]

Sorry.....losing is spelled with one o........and after maybe it should read.........manipulat... thats better.

Apr 22 08:22 PM

[buckbuck:]

manipulation!

Apr 22 08:22 PM

[Moon Kil Woong:]

I suggest when you look at market PE exclude banks. Their earnings are arbitrary and fictitious with current accounting laws and with recent FASB changes they are getting worse not better.

Apr 22 10:08 PM

[TheFounder:]

Good article. S&P at 800+ is still expensive and we should test the March lows again, maybe several times, and possibly even lower until a real base is established to match those economics.

Apr 23 01:23 AM

[Lee Eugene ...:]

Moon,
I understand your point, but the banks are integral for a sustained rally. We can't simply say they don't matter just because the books are cooked. They got a free ride this quarter with the new FASB rules and still can't make up for the lost time.
Thanks,
Lee


On Apr 22 10:08 PM Moon Kil Woong wrote:

> I suggest when you look at market PE exclude banks. Their earnings
> are arbitrary and fictitious with current accounting laws and with
> recent FASB changes they are getting worse not better.

Apr 29 12:07 AM

[Lee Eugene ...:]

I agree!!!!!!


On Apr 23 01:23 AM TheFounder wrote:

> Good article. S&P at 800+ is still expensive and we should test
> the March lows again, maybe several times, and possibly even lower
> until a real base is established to match those economics.

Apr 29 12:08 AM