Monday, June 13, 2016

Let's Talk About Earnings

There are several key sources for aggregate SPX (S&P 500 index) earnings (reported), and future earnings forecasts.  I ususally use Thomson Reuters (TR) SPX earnings reports, but Standard & Poor's (S&P) estimates (generated by Howard Silverblatt) are also widely quoted and followed.  If your ever wondering why the Wall Street Journal has one P/E number for the SPX, while Morningstar, Barron's and Zacks have other numbers, here is the explanation:

1. Most of the big finanical services use either TR or Howard Silverblatt's S&P for their earnings numbers, estimates and P/E ratios.

2. TR uses the most extreme non-GAAP number, which basically comes from analysts taking information directly from company's themselves.  Corporations are prone to put out the most favorable number possible when reporting earnings and estimating future earnings, i.e. these are the most adjusted, manipulated and doctored numbers within the confines of the law.  Hence, these are always the highest numbers and forward estimates, with the lowest P/E ratios.  Zacks, Factset and WSJ are examples of organizations that will use the most non-GAAP (manipulated) numbers possible when generating a foreward P/E for the SPX.  Here are the TR reports from the beginning of the April earnings season (reporting Q1 data) and today (from Friday's data):

 (click on image to enlarge)

(click on image to enlarge)

3. S&P reports an "adjusted" earnings number called Operating Earnings Per Share.  It is also a non-GAAP, pro forma number, but has been generated with tighter tolerances on what is allowed to create the operating earnings number.  As a results, this number is almost always lower than the TR number.  If the TR number is like non-GAAP on steroids, the S&P number is closer to the spirit of what non-GAAP allowances were created for.  On June 7th, with the SPX at 2112, the foreward P/E on TR was 17.1, while the foreward number at S&P was 18.4, which was quite a bit higher.

4. S&P also includes "as reported" earnings, which is the GAAP number.  Whenever you see a P/E ratio (trailing twelve month (TTM) or foreward) that is significantly higher than other numbers, it is probably generated from this report.  For instance, the TTM from TR on June 7th was 18.1, while the TTM for S&P "as reported" (from the June 1st data) was 24.4, a huge difference.  Here is the latest S&P report (from June 9th):

(click on image to enlarge)

Interestingly, the WSJ uses the S&P "as reported" data for its trailing SPX P/E, while using a Birinyi number that is close to the S&P "adjusted or operating earnings" P/E for the foreward estimate.  Needless to say, it can be confusing if you don't know where a business is getting its number, and if it's GAAP, non-GAAP or extremely non-GAAP.

I like using the TR estimates as a baseline for comparing earnings from one season to another.  I also like to see the most hopeful, sparkly, helium-filled numbers because chances are there are thousands of fund managers out there consuming that data and acting on it without regard to what's really under the hood.  However, I also like to use the S&P numbers to get an idea what many other thousands of fund managers may be consuming, and to see recent P/E history.

From the TR numbers we can see how estimates have changed from the beginning of the last earnings season until now.  Note that the foreward estimates for 2016 continue to drop (from 119.80 to 118.68), which is exactly what I have been predicting.  Those numbers will very likely keep falling through much of the rest of the year.  I expect 2016 to be the second year in a row of negative in, we are in an earnings in, we are in an economic recession even it is not being reported.  Also note that we did not add back the usual 1.00 to 1.50 on the Q1 earnings season.  We closed at 27.01 when, historically, we should have closed at around 27.50.  This is one more clue about just how difficult it has been the past several quarters for companies to play the normal earnings game of "beating" estimates.

From the S&P numbers we can see how nosebleed the true SPX P/E ratio really is.  A TTM of 24x and a foreward of almost 20x on the actual GAAP numbers is way over the historical average of 15.5x earnings.  The market is pricing in almost no risk as traders accept two key premises:

1. Low to negative interest rates will continue to force global fund managers into U.S equities if they want any real return on investments.

2. The Fed and central banks will have the market's back no matter what happens, and no matter what the real fundamentals show.

In my opinion, this is like playing musical chairs with your investments.  If you believe that those two key drivers of stocks will last forever, then beware when the music may not have a chair.  It's also why I refuse to advocate long-term investments right now.  Stay mobile, be nimble, stick with investments you are willing to sell after a few weeks or a couple months at the most.

I've written numerous times about the real, fundamental value of the SPX at a historically average P/E ratio is actually in the 1700's at the very best.  But now consider this:  The foreward estimates for the SPX which are holding down all the P/E ratios across all services are based on this:

(click on image to enlarge)

The snap-back in energy earnings for 2017 is to be expected, although I've written about $50 being the lid for oil, and real supply and demand eventually driving the latest artificial, central bank-driven oil rally back down into the $40's and $30's.  As a result, I think those estimates for energy are a little high.  The huge jumps in 2017 estimates for healthcare and tech are laughable.  Look for the 2017 TR estimates, which show an absurd jump from 118.68 to 135.75 in one year, to start plummeting in the coming quarters.  This will lead to higher and higher P/E ratios even if the market just rolls sideways.  Basically, any stock market upside for the next several months can only come on P/E expansion and not on earnings growth.

Can you see why there is a lid on the market?  If the Fed does manufacture a risk-on short-squeeze at this Wednesday's FOMC meeting (and I bet they will do exactly that), then expect another manipulated, low-volume rally that will be a selling opportunity, not a long-term investing opportunity.  Trade calls if we see it, but don't love the calls, just sell them after a week or so.  Meanwhile, I'm busy selling my puts into this pullback:

(click on image to enlarge)

Once again, low volume on the way up because the Fed and central banks are the market, and higher volume on the way down as everyone else that isn't a central bank or corporation flees.  I've already taken 1/4 of my puts out.  If we see the 50dma tomorrow morning, I will sell another 1/4, and if we go a little beyond, I'll sell at least 90% of my put positions if not all.  And if your wondering why I think the market will turn in space (again) on a breach of support, look no further than these recent photos from the ECB:

In the wake of recent controversy over buying IG and junk corporate bonds, the ECB just revealed pictures of its "trading operations" for the first time in order to calm everyone's fears that destruction of real price discovery or manipulation of the stock market wasn't the intent of the European central planners.  Perhaps they shouldn't have included this picture of a technical analysts deeply fixated on his price charts.  I'm guessing their "traders" know exactly where support and resistance are on the stock market and which patterns they do not want to see confirm:

(click on image to enlarge)

Based on the past 8 years of market technical charts and patterns I will continue to look for an inordinate number of V-bottoms and Crazy Ivans in the coming months as any bearish signal is quickly obliterated on CB buying...