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Don’t Get Suckered by “Good” Earnings

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07/24/09 Vancouver, British Columbia

In the market this week, it’s earnings, earnings and earnings. The Dow rallied big yesterday, up 2.1%, straight through 9,000, to its highest level since November. The S&P and Nasdaq were even better, up closer to 2.5%. Just as in the rallies over the last two weeks, blue chip earnings led the way… surprises from 3M, Hershey’s, eBay and Ford grabbed the spotlight this time.

Today won’t be so pleasant. It was Amex’s, Microsoft’s and Amazon’s turn to show their second-quarter hands today… and keeping with poker parlance, they were holdin’ rags. The market is consequently just below break-even as we write.

“The broad stock market,” writes Dan Amoss, “doesn’t see a difference between earnings achieved by cost cutting and earnings achieved by sales growth — especially in the consumer discretionary sector. Earnings achieved by cost cutting tend to be one-time in nature. These do not deserve higher multiples. The latter — earnings driven by sales growth — certainly merits higher multiples. We have seen very little of this, outside of unique companies like Apple.

“This is very important to keep in mind, because the rally in the market since the March lows is entirely driven by expansion in price-to-earnings multiples, not growth in earnings. This type of rally is fine if we’re at a trough in earnings and earnings are about to come roaring back as the economy recovers. But this type of earnings recovery is not going to happen. In the consumer discretionary and financial sectors, the market has gotten way ahead of itself. I expect this to correct itself as the fall season arrives.”

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Ian Mathias

Ian Mathias is managing editor of The 5 Min. Forecast.  We discovered Ian working as a full time rock climbing guide and writing on the side. As it turns out, markets and global economics can be extreme too… at least enough to keep him around. Since working for Agora Financial, respected media outlets including Forbes.com, the Associated Press, Yahoo, and MSN Money have syndicated his writing. He received his BA from Loyola College in Maryland and is currently studying writing at the graduate level.

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9 Responses

  1. Harry said

    I disagree. I think we’ll see the Dow at 10k by mid September and close to 12k by EOY. S&P is right around it’s historic range of 16 p/e on an inflation adjusted basis. So stocks are priced correctly with room to run. What’s going to stop tech?? Obviously, the demand is there and enterprise spending is up. I only see growth ahead.

    on July 24, 2009.
  2. Jackie said

    what happens when others balk at buying US debt?

    on July 24, 2009.
  3. Don said

    Oh, Oh, Oh, I can answer that….we will buy our own debt, and my TBT will go nowhere to down. Just my luck. Snookered again by the people that make and change the rules of the game. But I am not bitter.

    on July 24, 2009.
  4. Kurz said

    Plunge protection team anyone?

    on July 25, 2009.
  5. azpatriot said

    sure, buy stock!!! suckas!!!! pure gambling at this stage. no earnings!!!
    no growth, high unemployment, hahaha

    on July 25, 2009.
  6. gjgjhgjhg said

    stocks have nothing to do with earnings/ pe/ etc. They are a legalized paper mechanism for printing money and handing it to the population…

    they have nothing to do with “value”

    on July 25, 2009.
  7. Oliver K. Burrows III said

    An inflation adjusted price/earnings ratio of 16 bodes well for you if and only if there is substance, such as sales growth, behind those numbers. With a real unemployment rate, based on historical Bureau of Labor Statistics parameters, at in excessof 16%, the price/earnings ratio data is skewed.

    on July 25, 2009.
  8. tony bonn said

    that 16 p/e is for the last 4 quarters with the first two of those hardly reflective of current 20+% unemployment and prior to 2 trillion dollars of deficit….if you are an astute time series statistician you would probably weight the nearer events more heavily than the remote….as such p/e ratios are closer to triple digits….and please don’t spew that crap about the stock market being forward looking since it didn’t have a clue about the current down turn….and then explain about 2 trillion usd of bad real estate is going to be handled and how falling real estate prices is good for stocks….

    the market may keep rising – it’s certainly higher than i ever expected…but the fundamentals are not there….

    on July 27, 2009.
  9. lana said

    fundamentals are the key ! That is what we were taught right!

    on July 27, 2009.

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