Forward
earnings projections for the S&P 500 are at record highs. Glass half full – earnings should continue to
improve. Glass half empty – high
earnings means high expectations.
Rather than project where earnings will be, I will give my
interpretation of how to read the consensus.
This
chart from Dr. Ed’s blog helps:
While difficult to read (so see the notes), some things
stick out:
- The bulk of the time forward projections are too high start too high (see the blue lines trending down)
- Forward earnings projections tend to be reliable (notice slope of blue line is small) most of the time…
- Unless there is a recession (see the slope of the blue line is massively negative 2001, 2008, 2009)
- Even if forward earnings projections move down, sideways, or slow in growth, equities can still advance due to multiple expansion, i.e. stocks become more expensive relative to the earnings they produce (see the red line in 2012 and 2013)
- Though there is certainly a limit on this expansion, for instance a forward PE in the mid 20s in 2000 was certainly an alarm signal when the long-term average is around 15
And my subsequent takeaways:
- We are below the longer-term average on forward PE, thus even if forward earnings come down the equity markets can move higher
- An exception to this would be if we hit a recession, in which case all bets are off
- Another would be if the multiple gets too high, where falling earnings would yield a falling equity market as multiple expansion can’t offset the decrease in earnings
- We are currently around 14 P/E. In 2007 at the peak we were around 15 and 25 in 2000.
- Thus given we appear to be at a reasonable valuation level on this metric, the risk to stocks lies in the risk of a recession
- So far the data doesn’t seem to indicate a recession is coming
- Still, since equity markets tend to lead the recession (even ones that don’t come to be) it’s important to gauge the momentum of the market for any possible hint
The views and opinions expressed herein are those of the
author(s) noted and may or may not represent the views of Capital Analysts,
Inc. or Lincoln Investment. The material
presented is provided for informational purposes only. Nothing contained herein
should be construed as a recommendation to buy or sell any securities. As with
all investments, past performance is no guarantee of future results. No person
or system can predict the market. All investments are subject to risk,
including the risk of principal loss.
