As I mentioned in a previous article, earnings estimates vary widely. Anything can happen in a sense. The bull case before the election was that margins would increase to record highs. With the Trump tax cuts potentially in place, there are further tailwinds to earnings rising quickly. On the bear side, earnings estimates have been missed throughout this recovery. Given that 2017 GDP growth is starting off with a whimper, that doesn’t bode well for earnings this year. While tax cuts may occur, there hasn’t been a clear path for a plan to pass Congress yet. It has been 100 days and all we’ve seen is a one page proposal which has guidelines which were laid out months ago. The fact that there’s a low probability that the government can shut down shows how disoriented Washington D.C. is now. That’s not a political statement. The reason the tax code and healthcare system need reform is because politicians for decades haven’t been able to solve the problems.
The chart below summarizes the bearish case for earnings quite well. As the saying goes, ‘fool me once shame on you, fool me twice shame on me.’ In this case earnings estimates have fooled investors multiple times. The correct description is willful ignorance. Investors on Wall Street want to keep the party going, so they are willing to plug optimistic estimates into their models even though they keep missing the mark. It’s not like it is one analyst making wrong predictions. The consensus has been wrong. Even though it has been wrong, it’s not easy to ignore them. The endless cycle of predicting great future results never deals with reality because after bad results are reported, they are already in the past, making them not matter to these ‘forward looking’ investors. This doesn’t mean investors should stop forecasting future cash flows; it means being realistic should be the goal.
The chart below shows what the S&P 500 would be at using a 15 multiple on various earnings estimates. Stocks barely fell even though there was an earnings recession. Each successive estimate falls but stocks keep rising. It makes you question the entire perspective of this article. I’m discussing whether earnings will rise or fall, but those who predicted the earnings recession where only rewarded with a flat market. I still think fundamental analysis matters even though it has been ignored.
Leave A Comment