If you have kids, you may remember the Sesame Street segment
"Which One of These Things Does Not Belong Here?"
You may also remember the tune that went along with it: "One of
these things is not like the others, one of these things just
doesn't belong, can you tell which thing is not like the others, by
the time I finish my song?"
We are about to play a similar game.
S&P Price Target Raised, Earnings Remain Flat
Over the weekend, Bloomberg reported:
"The same analysts who lowered second-quarter profit growth
predictions to almost nothing in 2013 are raising (S&P) price
forecasts (NYSEARCA:SPY) . Standard and Poor's 500 Index earnings
rose 1.8% last quarter, down from a projection of 8.7% six months
ago, according to more than 11,000 analyst estimates. The US equity
gauge will increase 8.9% to a record 1778, should their (updated)
forecasts prove accurate."
Their reasons for upping their S&P target price (NYSEARCA:SSO)
range from "Investor confidence is growing" to "the economy is
gaining sustainable momentum." But if that's really the case, then
why wouldn't you also expect earnings estimates to rise instead of
their recent declines?
How Bad is the Earnings Guidance for the Second
Business Insider notes, "The percentage of companies issuing
negative EPS guidance is 81%; if this is the final percentage for
the quarter, it will mark the highest percentage of companies
issuing negative EPS guidance for a quarter."
So, let me get this straight: This is the worst quarter ever for
earnings guidance, but Wall Street analysts still continue to raise
their S&P price targets?! Looking at the recent trend of
earnings estimates, one must really question Wall Street's ability
(or CEOs' abilities, for that matter) to even predict earnings in
the first place (more on that below).
On June 25, I looked at the very long-term trend of earnings growth
and wrote, "Throughout 142 years of history, investors should
expect earnings to decline 10% year over year on average once every
five quarters, and an earnings decline over 20% should be expected
10% of the time, or once out of every ten quarters (2.5 years)."
It has now been four years since we have seen any significant
negative earnings growth. In that analysis, it was also very clear
that earnings do not grow positively into perpetuity, and after
four years since any significant decline, the business cycle may be
ready to again take hold.
Rising Prices on Lowered Earnings
In an example from the first major S&P component to report,
) Q2 adjusted earnings of $0.07 "beat" its estimate of $0.06.
Not mentioned by the news sources though is that Alcoa's Q2
earnings estimate was way up at $0.60 in early 2011 and at $0.28
last year. The company has dropped its earnings estimate by over
90% since it started giving guidance. With estimates that far off,
it is amazing we put any trust in estimates in the first place.
When prices rise (NYSEARCA:IWM) and earnings do not, this means one
thing: Investors are paying more for a product that is delivering
less. But starting out with extremely high estimates that are then
dropped through time is nothing new.
The charts below from Standard and Poor's show this trend for the
(INDEXSP:.INX) over the last two years. A look back to the '90s
shows this practice is actually the norm.
Reality shows that S&P earnings estimates have been declining
since 2011, meaning that prices (along with P/E ratios) are rising
(NYSEARCA:DVY) for reasons beyond underlying fundamental
expectations. This also means that investors have been paying more
and getting less during that time.
Whatever the reasons, without earnings to eventually accompany,
share price (NYSEARCA:SPXS) growth is likely unsustainable over the
Figure 1: Can You Find the Outlier?
The first two charts above show how analysts have been lowering
earnings guidance for well over two years now. Estimates were
lowered around 10% by the third quarter of 2012, and down over 15%
to just $97 by the time 2012 was completed (not shown). This
resulted in a P/E ratio (NYSEARCA:UPRO) that jumped from 12x to 15x
by Dec 2012.
Again, the latest earnings estimates for 2013 have been
significantly lowered through time, also down around 10% (so far)
and also resulting in a significantly higher real P/E ratio,
currently over 16x (NYSEARCA:IVV). If earnings continue to decline,
this just means the P/E will go higher.
One of These Things Does Not Belong Here
Looking at the final chart above of 2014 earnings estimates, we see
a chart that clearly look different. For the first three months
that 2014 has been estimated, earnings are expected to be higher
and rising, as businesses are still focusing on 2013.
The same thing occurred with 2012's and 2013's earnings estimates
that were also initially expected to rise. That is, until reality
set in, CEOs started to get visibility, actual earnings started to
disappoint, and future estimates were finally lowered.
2013's decline continues today as the 2013 chart in Figure 1 above
shows. If 2012 is any lesson, it would not be surprising to see
2013 earnings follow 2012's footprint and continue to be ratcheted
down through December.
For now, 2014's estimates remain the odd chart out -- that is,
until CEOs start to actually look at the significantly higher 2014
earnings targets and also start ratcheting them down.
Given Wall Street's horrid history of earnings estimates, we should
expect 2014 earnings estimates to eventually be pulled back as 2013
estimates continue to disappoint.
Editor's note: This story by Chad Karnes originally appeared on
To read more from ETFguide, see:
Why Are TIPS Losing Value?
It's Official, Gold Was a Bubble
The Three Biggest Investment Trends of 2013