Gloomy Earnings Prospects Hold Key to Stock Buying
By Martin Hutchinson
Contributing Editor
Money Morning
The consensus estimate of earnings for the Standard and Poor’s 500 Index for 2009 is currently about $83. The index itself is currently standing at about 904. That means the market is trading on only 10.6 times next year’s forecast earnings, far below the historical average multiple.
So it is a screaming buy, right?
Not so fast.
“Consensus” estimates of earnings lag reality substantially. Because they include an average of all earnings forecasts over a considerable period, forecasts made in late September would still be included in today’s consensus estimate. But in a period such as the present, when reality has changed substantially since September, the official consensus forecast may differ wildly from what most analysts currently believe. The $83 number is thus a lagging indicator, which doesn’t take account of financial sector disasters, sharply slowing output, or tight credit conditions.
Most analysts, finally made more cautious by five successive quarters of declining earnings on the S&P 500 index, currently believe that the S&P 500 will earn about $60 in 2009. What’s more, David Rosenberg of Merrill Lynch & Co. Inc. (MER), who has been exceptionally bearish for some time with an estimate of $50, has been joined in bearishness by Goldman Sachs Group Inc. (GS), which has brought its group estimate down to $53.
That’s much more scary. Taking the average S&P 500 multiple at around 14 times earnings, an earnings estimate of $60 would put a “median” estimate of the index at 840; an earnings estimate of $50 would put it at 700. Take a bear market low at 10 times earnings, and you could postulate an S&P 500 low of 600 or even 500.
Still, bear market earnings estimates can be taken only so far, especially those of analysts. After all, on July 7, 2008, a joint report by two top houses predicted that the S&P 500 index would have its best six months since 1982 in the latter half of 2008. That’s about as wrong as they could possibly have been!
Still, one should not be surprised by their failure; while one of the two well respected but wrong houses was Deutsche Bank AG (DB), the other was – Lehman Brothers Holdings Inc. (OTC: LEHMQ). Truly, a lot can change in six months.
2009 Bears
Nevertheless, while it’s clear that from an earnings viewpoint 2009 should be approached with caution, it is also clear that some sectors and countries will do reasonably well, while others have futures that are truly scary.
Some of the more bearish sectors and regions include:
• Financial services: The entire industry appears to be scaling down to a fraction of its 2007 size, as many of the innovations of the last 20 years turn out to have been spurious. Investment management also is destined to be much less innovative and less lucrative in the wake of the Bernard Madoff scandal. Eventually, banks and other financial institutions will emerge from the downsizing, but 2009 is much too early to expect that.
• Real estate and construction: Housing won’t bottom out until mid-2009 at the earliest, and will recover only very slowly thereafter. Non-residential construction will also be very limited, as offices, stores and hotels will be in glut. There may be some money to be made in road construction from President-elect Obama’s infrastructure program, however.
• Emerging markets with no money: The emerging markets that rely on borrowing to fund themselves will be out of luck, as debt will be expensive and hard to come by. Eastern Europe and most of Latin America will be in for a thin time, as their balance of payments and in many cases budget deficits will take years to straighten out.
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• Western European countries with high cost bases: The Western European countries with expensive labor and high taxes will find life tough in 2009, particularly if they previously enjoyed a real estate bubble or were big in finance. Germany will probably do fine because its high-skill labor is highly competitive and it had no housing boom; Britain, Spain and Italy will be in a much more difficult situation.
2009 Bulls
Conversely, there will be sectors and countries whose earnings can be expected to hold up well, and whose shares are worth looking at:
• Gold mines: Inflation is almost certain to return in 2009, because of all the fiscal and monetary stimulus. That has to be bullish for gold, other precious metals, and mining companies.
• U.S. exporters: The rest of the world will show some economic growth, and the U.S. budget and payments deficits and expansionary monetary policy will make U.S. exporters benefit, unless they are involved in businesses that depends heavily on tourism, such as aircraft.
• Healthcare providers: Pharmaceutical companies may have problems with President elect Barack Obama’s healthcare plans, because the returns for patented drugs will be reduced, but hospital chains and other healthcare providers will probably benefit from an overall increase in government healthcare spending.
• Asian countries: In general, Asian countries will do better than the United States and Western Europe, because their cost bases are less overblown and their competitiveness is greater. China and India may have problems, but I like the prospects for Korea, Taiwan and Japan and for companies in those countries involved primarily in their domestic markets. If the Indian election in spring goes to the pro-business BJP party, it will be a buy too; if not, India will have difficulty funding its overblown government sector.
• Brazil: Brazil has a well-balanced economy, less foreign debt than it used to have, and a monetary policy of high real interest rates. It can, therefore, afford to expand domestically through monetary means in a way no other country can.
News and Related Story Links:
- Money Morning:
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- Money Morning:
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Comment by Dr.Frank Loo on 2 January 2009:
According to you China may have problems. Can you please spell out the problems China may encounter in 2009. Thanks.
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Comment by Dan on 2 January 2009:
China’s problem will be as thus. Foreign demand will dry up as comsumers in western countries will have no money to spend. Acutally that will be a problem for most asian countries. Domestic demand will be poor as they have a billion poor people who are all very stingy and will not spend very much as compared to their western counterparts.
To solve this dilema china should concentrate on building its economy eg housing, infratructure around green sustainable technology which does not rely on foriegn imports of meterials all the time.
It should postpone company tax by 2 years thereby allowing companies to spend more money and delay a tax liability.
China will have to prop up the usd otherwise the dollar will lose value quickly and hence thier billions of investments will go down the tube. To avoid this china should buy les USD and start buying back it’s USD.
Although short term the USD will go down as no body will want to spend thier money. USA consumers still have a lot of money to spend but will only spend on necessities. Long term after prices have dropped money will fly back to the usa as investors take account of cheap prices, high yields. Also as the usd is the worlds reserve currency so it will be in high demand once the eonomy picks up
China should increas it’s trade will all other countries less it becomes too dependent again in the future on just the USA consumers and develop its economy on green technology to avoid a high cost base in the future (high energy, metal prices leading to high prices for all items)
that is my 2 cents
Cheers and have a very happy new year
Comment by gustongroves on 3 January 2009:
Gold is the positive sign that would definitely help the stock market bullish, I think. Hope in 2009 financial position of every country would improve
Comment by dan on 4 January 2009:
All companies especially those in asia with big cash piles should acuire as many quality companies as they can ala Berkshire hathaway. This will enable thier revenue stremas to be diversifeid and allow for a softening of any possbile hardlanding. the risks are that the acuired companies will be dudes eg blackstone or that governments will not allow any foreign ownership
Pingback by Bookkeeping: Weekly Changes to Fund Positions Year 2, Week 22 | ø§§» INVEST News, Tips, & Analysis ø§§» on 5 January 2009:
[...] more likely scenarios are something in the $45-$55 range. And I lean to the low end of that… Merrill Lynch has now dropped their estimate to $50, and Goldman Sachs to $53. So I’m not out of line here. [...]