Posted on 09/04/2002 6:42:19 AM PDT by SJackson
Edited on 04/22/2004 11:47:01 PM PDT by Jim Robinson. [history]
That's the myth but it can't be true, can it? I mean, I remember the hype about the New Economy, but the leaders of American industry bought it? Pathetic if true.
That's like saying that because people were wrong when they said the Earth was flat, that they are now all wrong becuase they think the Earth is round. It just doesn't follow.
But here's the question- Is the contrarian viewpoint (lets start buying on the dips) the groupthink or is the bearish viewpoint (woe is me) the groupthink? And if everyone is in groupthink mode, is the attempt to outguess groupthink itself a form of groupthink? Perhaps the 'real' contrarian viewpoint is the bearish view.
This just in... 2+2=4.
The flaw in this analogy is that the earth doesn't change from flat to round to flat etc. The economy does change from hot to cold to hot. Over the years, the consensus has a remarkable record of nearly always being wrong.
Ah, but how do you KNOW this to be true???
Ha! Gotchya!
Which, as a consensus viewpoint, is probably wrong itself. How long has sentiment in Japan been bearish? Any contrarians care to buy some Japanese stocks? You get negative sentiment when things stink. It does not follow that it is therefore a good time to buy. Bearish sentiment does not necessarily foreshadow future improvements.
Next, understand that real earnings for the SP500, including whatever accounting they were playing then, peaked in 2000 at about $52 for the SP500 - with the index at 1500, making for a PE at the market peak of 29. Five years ago, back in 1997 with the SP500 at 950 on the way up, the as reported earnings of the index were $40.60, making for a PE of 23. Yes Virginia, the PE on reported earnings is higher now than it was when the index peaked at 1500, because the earnings have moved down faster than the price.
But some of that is also fictional. In 3 out of 4 quarters of 2001, the companies in the SP500 took out the accounting trash. They reported low earnings, on the order of $5 a quarter, when they had been regularly reporting $8-10 per quarter. They stuffed in all their write-offs, they acknowledged the losses on all their venture equity, etc. The earnings for 2000 had been inflated to $13 a quarter for a like period, at stock gains were recognized, etc. That is just moving around earnings in time. They were boosted in 2000, then were scalped in 2001, from their trend.
How can one tell that is what was happening, that is was accounting games? Simple, you cross check what the companies tell their investors with what they tell the US government, in the form of the IRS rather than the SEC. The Fed reports corporate profits after taxes regularly. The SP500 is more than half the economy - it cannot realistically move around in dramatically different ways than the overall corporate profit sector. What does the Fed say happened to US after tax profits between 1997 and 2002, when all of those stock market fireworks were going on?
Answer - not a bleeding thing. In 1997, over four quarters the US corporate sector earned $562 billion after taxes. In the last 4 quarters, the US corporate sector earned $575 billion after taxes. In the 2000 4-quarter period when the stock prices peaked, the US corporate sector earned $547 billion after taxes. These numbers are all within 5% of each other. The variations are as much in tax rates (29% on average in 1997, 25% average in the last 12 months) as anything in pretax corporate profits.
In other words, corporate profits hit a plateau in 1997, around the time of the Asia crisis, and have been moving sideways on that plateau ever since, with no additional growth, no spike upward in 2000, no crash back afterwards. Those movements are mirrored results of the stock price indexes themselves, as companies booked profits or book write-downs on their own market speculations in spin offs and venture companies and cross holdings and the like. They have nothing to do with the underlying earning power of US companies.
The jump from the 1997 level of the SP500 to the 2000 peak was pure hype, spin, and bootstrapping. The hangover of 2001 was simply undoing some of the bootstrapping when all the venture investments did not grow to the sky. US corporations are about as valuable now as in 1997, in their real ability to earn money on average, over long periods, not due to accounting games.
If you look at the data in financial publications like the WSJ or Barrons, you will notice the curious fact that the trailing earnings estimates give PEs in the 30s and the forward ones give PEs in the teens. And you have to wonder if that is all nonsense, just spin. The answer is that much of it is nonsense, but not all.
The reality is the 2001 write-down quarters when the SP500 reported earnings of $5 a quarter are not going to be repeated. But neither is the index going to jump to earning $15 a quarter, above the inflated 2000 level. Instead, it is going to earn about $10 a quarter, about the same as it did in 1997, because overall corporate profits are on the same plateau as back then. If things go badly, maybe as low as $8-9, if things go well, maybe as high as $11-12 - which will sum out over a year to $35-45. Which means the PE on the SP500's real earning power is 20-25 times. What a surprise.
In the short run the stock market is a voting machine. In the long run the stock market is a weighing machine. So said Ben Graham, and he was right. Overall corporate profits are not going to explode to double their past levels. There is no sign of the sustained and rapid growth in overall after tax corporate profits needed to make that happen. For five years corporate profits have been going nowhere. Neither are the cut-in-half write downs of a few "take out the trash" quarters of 2001 going to be repeated.
Now, one can reasonable ask, is the SP500 *worth* 20-25 times earnings when overall corporate profits aren't particularly going anywhere, having been remarkably stable over the past five years? Probably not. Interest rates are low, but that PE level reflects no risk premium at all for stocks. The "E over P" is about the same as long term treasury yields. In the long term past, you could easily expect PEs more like 14-15, reflecting 2-3% risk premiums for stocks. Meaning there is potential downside still, which might easily amount to 30-45% more in the way of declines. As for the upside, it is only long term GNP growth, which will eventually move corporate profits. There is little reason to expect multiples to expand beyond the mid 20s on sustainable earnings.
What will the *operating* earnings of the SP500 be over the next 12 months? Whatever Peter Pan says they are. What will the real earnings of the SP500 be over the next 12 months? $45 would be a strong performance, and they will not hit $60. You shouldn't be surprised if they are $35-40 instead of $45. They will go up, because it is easy as pie to beat the artificially depressed year ago levels, full of post bubble write-downs. But that doesn't mean roaring growth is back after a minor pause, it is just a return to normal levels. And the growth hasn't really been roaring since 1997, anyway.
I hope this is interesting.
Don't we also have to factor in the bogus earnings estimates that the Clinton era OMB was putting out on a quarterly basis, that overstated quarterly earning in year 2000 by as much as 38%, an increase from the bogus statistics of 1999 that overstated corporate profits by "only 25%". This misstatement helped to create the investor frenzy, and also formed the basis of the "ten year forward tax surplus" which formed the basis of the Bush tax cut strategy, that will now bite us in the behind.
Another Clinton legacy.
Great post.
Very interesting.
Thanks.
Yes, and thanks.
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