S&P 500: Earnings Do Not Add Up

Includes: DIA, IWM, QQQ, SPY
by: Stock Traders Daily

By Thomas H. Kee Jr., Stock Traders Daily

We are halfway through this earnings season. The media hype around some of the earnings reports has reminded us of the Internet bubble and the peak of the credit bubble in 2000 and 2007 respectively, but it is not over yet.

Anyone who reviews Standard and Poor's analysis closely realizes that analysts have been expecting EPS growth of 17.72% for the S&P 500, year-over-year. That means that analysts expect this earnings reporting season to better the same quarter from last year by 17.72%. This is, by all accounts, a very lofty expectation, and largely it is because of that expectation that the S&P 500 is where it is today.

With help from the media of course, bullish investors have had a field day during this slow summer season. They are considering good numbers great, and they are discounting the negatives completely. Of course, there are exceptions like we saw in Microsoft Corporation (NASDAQ:MSFT), but they discounted an earnings miss from Amazon Amazon.com, Inc. (NASDAQ:AMZN), and they are applauding companies who are actually earning less and generating less revenue, even though their stock prices are increasing along with the market.

This is typical of a bullish market environment, but what is also typical of the bullish market environment is that investors stop paying attention to the facts. They listen to the headlines, they begin to get greedy, and they start to forget about prudent investment practices. That case in fact is exactly what seems to be happening now.

For almost every day over at least the past few days, including the day Amazon reported earnings, investors piled into large cap tech (ProShares Ultra QQQ (ETF) (NYSEARCA:QLD)) at the very end of the day, anticipating a pop the next day. This was palpable, but buyers were obvious, as were their intentions. They did not intend to invest, they intended to make a quick buck, and thus far that is exactly what they have been doing.

This is an example of greed, this is also an example of discounting the facts, but in this case the facts reveal something that brings this entire market rally into question. Analysts are expecting EPS growth of 17.72% for the S&P 500, more than half of the S&P 500 has reported earnings, but the earnings growth thus far, even with media hype and the greedy tone that overhangs this market, has not come close to keeping pace with those estimates.

Based on those estimates, the as reported PE ratio for the S&P 500 is 18.47 times earnings. This assumes a 17.72% EPS growth rate for this quarter and growth rates in excess of 20% for the next few consecutive quarters, something that we at Stock Traders Daily are questioning. Our earnings analysis is telling us something different, it is a warning that those expectations were far too high, and if those expectations are not met, our combined analysis further warns us that the current price earnings multiple of the S&P 500 will increase measurably. Not only that, so will the PEG ratio.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: By Thomas H. Kee Jr. for Stock Traders Daily, and neither receive compensation from the publicly traded companies mentioned here for writing this article.