One of the reasons sell-side analysts on Wall Street are usually pretty bad at picking stocks is because they are reactionary, not anticipatory. Remember, the market is forward-looking, so what already happened is irrelevant.
Here we are, in a recession, and by most accounts the economy will stay bad well into 2009. And yet, the consensus estimate for 2009 S&P 500 operating earnings stood at $100.90 as of 10/14. That compares with a 2008 estimate of $75.94, which means the sell-side is projecting earnings growth next year of 33%. Absolutely nuts, right?
The problem is that analysts won’t ratchet down their numbers until the companies actually come out and give specific 2009 guidance (they wait to be spoon-fed it, rather than anticipating it ahead of time like the market does). In such an uncertain economic environment, firms are uneasy about projecting earnings for this quarter, let alone next year. As a result, we have everyone on Wall Street well aware that 2009 earnings for the S&P 500 will be nowhere near $101 (hence the market has tanked), except the analysts won’t tweak their official forecasts ahead of time.
Look, how long the bear market lasts will likely depend on how long the economy stays weak, but how far the market ultimately falls during the bear market will depend, in large part, to how far earnings fall. As you can see below, S&P 500 operating earnings peaked way back in 2006 before oil prices spiked and hurt many companies who have oil as a major input cost.
S&P 500 Operating Earnings:
Obviously the 2009 number is crazy, but how far will earnings drop? The headwind is the recession we are facing, but with that we are seeing commodity prices come crashing down. That will help profit margins at most companies because their expenses will drop alongside their revenues.
Even if we see a recession during most of 2009, earnings might hold up better than some pessimists think. If that is the case, it should put a floor under stock prices next year, even if we hover along that floor for a while. So, the thing to watch is not whether $101 of S&P 500 earnings is doable in 2009 (it isn’t), but rather if we can manage $70 to $75, which would make some of the more dire predictions of $50 or $60 overly pessimistic.