My correspondent Ted Kavadas writes great stuff at
Prosperity by Pen, which is on the blogroll. He has an article entitled "A S&P500 Target of 100? Impossible, Improbable, or Impending?" It relies on the fact that there is little technical support between recent S&P 500 Index lows and 100, and little in the way of current earnings to prevent the index from crashing to such a level.
It's interesting as his work always is. And from the point of view of gaining publicity for an idea it never hurts to be extreme . . . wasn't Harry Dent calling for Dow 45,000 before he decided that the Dow has strong support down around zero? (I did this myself once, calling for an Indonesian Rupiah at 10,000 to the dollar at a time when it was around 1,700 -- but I was not extreme enough as it ultimately went north of 15,000)
The first material critique I make to the argument is that markets do not look only at current year (year 1) earnings, but look beyond the earnings trough, whether that is this year or next year or whenever. Market participants can be wrong about that and need to reset expectations, but there is no way they drive the S&P to 100 based on current year earnings estimates, without other things happening (e.g. the financial system collapses despite all efforts, terrorism hits us at home in a spectacular way, Obama embraces Chavez-ism.)
Second, market participants have already largely discounted the work product of the analysts, who have proven again that as a group they are no use under deeply cyclical conditions. The shock value of their downgrades is more limited now. Certain analysts who have made particularly good calls are exempted from the criticism that they don't know how to analyze in this economy, but even they are finding it hard to shock the market at this point.
Third, given the cyclical conditions, participants will prefer to consider earnings over a longer segment of a full cycle than just one year. I have heard of people calibrating valuation to an average over ten years. No one can forecast year 10 earnings for any company, but if investors are finding this approach works for them that's great.
Fourth, and maybe the big one. Let's not forget that current earnings are heavily penalized by non-cash charges. This is the central problem of our markets today, the fact that charges required by mark-to-market accounting have demolished the capital of the financial system, requiring markdowns and charges on assets even if they are performing. It's madness, but it's the system we have now. If you are of the opinion, as I am, that much of this capital destruction is unreal and unnecessary, then true earnings, though depressed, are still higher than reported. It is not only financial companies that are taking these charges because they are forced to. Other companies are "kitchen-sinking" their earnings in order to get out whatever bad news they could conceivably ever have at a time when markets are inured to bad news. Hence Nike recently wrote down Umbro, which they bought mere months ago and now declare impaired, taking a heavy hit to earnings in the current period. This charge is wholly discretionary. They did not have to take it now or probably ever. This is why some participants prefer cash flow to manipulable reported earnings. Earnings lie, cash flows tell the truth.
Labels: Accounting, Analysts, Banks, Board Sports, Brands, Earnings, Financial Crisis
