Fantasy Versus Reality

| About: SPDR S&P (SPY)
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Summary

The perpetual optimism of the corporate earnings forecast is remarkable.

It is notable how widely divergent these earnings forecasts are from the actual outcomes that ultimately come to pass.

Beware the forward price-to-earnings ratio.

The perpetual optimism of the corporate earnings forecast is remarkable. And while its well understood that things almost never turn out as good as we might anticipate, it is notable how widely divergent these earnings forecasts are from the actual outcomes that ultimately come to pass. Beware the analysis pinning its conclusions on the forward price-to-earnings ratio on the S&P 500 Index or any of its constituents for that matter, for it may lead to conclusions that are ultimately built on sand.

For the purpose of this discussion, let's consider the forecasted earnings on the S&P 500 Index (NYSEARCA:SPY) as of the end of the third quarter in 2015. At the time, the S&P 500 Index was in the process of wrapping up its third consecutive quarter of declining annual as reported earnings growth. And while the upcoming Q4 quarter was projected to present continued challenges, the pace of the decline was expected to abate. By the first quarter of 2016, as reported earnings were predicted to return to positive territory. And by Q2 2016, we would be launching into a stretch where annual earnings growth would be exploding higher at a +15% to +25% pace. Never mind that this ambitious forecast represented a complete and total trend reversal from the more than a year's worth of data that preceded it. Believe in the forecast, and the valuation on the stock market that would soon be striding its way back above 2000 on the S&P 500 Index would look much more reasonable.

Unfortunately for those providing these corporate earnings projections, time does pass and with it reality sets in. As it turns out, by the time 2015 was drawing to a close, the results for the second quarter of 2015 turned out worse than expected. And so to were the annual as reported earnings results for the third quarter of 2015 coming in well below forecast (despite the fact that a remarkable 77% of companies on the S&P 500 Index either beat or met consensus earnings expectations for Q3 - remarkably farcical that is). And while Q4 earnings projections were still expected to show a deceleration in the growth decline, the results were looking worse than originally believed. What about the growth explosion that was projected to follow? Not much was expected of Q1, but investors were told to expect even less. And the big burst higher for Q2? Still expect double-digit growth, the consensus forecasters said, but no longer in the high teens but instead in the low teens, as this earnings growth was being pushed back toward the second half of 2016 with forecasted earnings that were projected to come in even better than projected at the end of Q3 in the ~25% range.

OK. So we should have expected a bang up second half of 2016 heading into the New Year according to these forecasts. But once again reality is undermining such wishful thinking. So here we stand in the middle of the first quarter of 2016. Roughly 84% of companies have reported Q4 2015 earnings, and annual as reported earnings growth is setting up to fall by double-digits just as it did in the previous quarter. And annual earnings growth that was projected to be positive in Q1 has since turned meaningfully negative at a projected -5%. At least we have Q2, right? Not any more, as double-digit annual earnings growth has since shrunk to below 5% and fading fast. Moreover, that +25% earnings growth forecast for Q3 has fallen back into the high teens. But of course, we should now expect +25% for 2016 Q4. I'll believe it when I can see it as fact.

Clearly, relying on corporate earnings forecasts for the basis of investment decision making should be done at an investors own risk. Forecasts start out as wildly optimistic, with greater hopes the longer the time horizon. Which leads to a final point worth mentioning. Standard & Poor's recently released a first look at the earnings forecasts for 2017. And if past experience is any guide, it may be indicating trouble on the horizon for the coming year. For instead of the robust +20% earnings forecasts throughout 2017, we instead see a notable fade as the year progresses. Perhaps these forecasts will improve with the passage of time. But if forecasters are this unenthusiastic about a point that is so far away in the future, what will the reality look like once we finally arrive?

Only time will tell.

Disclosure: This article is for information purposes only. There are risks involved with investing including loss of principal. Gerring Capital Partners makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made. There is no guarantee that the goals of the strategies discussed by Gerring Capital Partners will be met.

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

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.