VERSACE: When will earnings catch up to economic reality?

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ANALYSIS/OPINION:

Over the past several trading days, one might be tempted to say economic reality has started to catch up with expectations. Reading over the rash of downgrades by economists at several Wall Street brokerage firms and elsewhere, I started to think that was the case, particularly following the drop in the stock market late last week.

That was until the rebound in the stock market earlier this week, which saw a 55 point gain for the S&P 500, even though the economic news was lukewarm at best and far worse upon digging past the headlines. Moreover, more economists cut their growth expectations for both the U.S. and the rest of the globe for the balance of 2011 and all of 2012. Oh, yeah, forecasts for the domestic unemployment rate were also ratcheted up for both of those periods.

According to an Associated Press poll of 43 private, corporate and academic economists surveyed this month, after growing at 1.3 percent in the second quarter of this year per gross domestic product (GDP) figures, the economy is expected to grow 2 percent in the July through September quarter, and 2.2 percent from October through December.

That same group sees the unemployment rate exiting 2011 near 9 percent and 8.5 percent in 2012; while both of those figures are better than the 9.1 percent employment rate in July, neither signals a booming recovery ahead. Lastly, a major potential risk identified by the group was consumer spending, as in weakening consumer spending.

Also this week, the Congressional Budget Office (CBO) released its annual summer update of the budget and economic outlook. That update now calls for 2.3 percent GDP growth this year and 2.7 percent next year and a national unemployment rate that “will remain above 8 percent until 2014.” Near term, the CBO’s summer update sees the unemployment rate falling to 8.9 percent in the fourth quarter of this year and to 8.5 percent in the fourth quarter of 2012.

Some, including myself, would say the above economic growth forecasts remain far too rosy, given the economic data seen in recent weeks. Those who might challenge the assumptions on which the above forecasts are based include IHS Global Insight, J.P. Morgan and Goldman Sachs.

IHS Global Insight recently lowered its growth forecast to 1.2 percent in the current quarter and 1.5 percent in the fourth quarter from 3 percent or more. Economists at J.P. Morgan just lowered their growth outlook to just 1 percent over the next four quarters, after projecting growth of as much as 2.5 percent in the fourth quarter. Last Friday, Goldman Sachs again cut its estimates for U.S. economic growth in the second half of this year to between 1 percent and 1.5 percent, both down from 2.0 percent previously.

Despite the negative economic-outlook revisions across the board, one area that has yet to catch up is analysts’ expectations for earnings and earnings growth for the S&P 500. Per data compiled by Thomson One, consensus expectations still have the S&P 500 on track to deliver $95.91 in earnings per share this year and rising to $104.59 next year versus $85.28 in 2010.

Critics often say that analysts are slow to react and adjust what tend to be more positive outlooks. Instead of being ahead of the curve, many analysts tend to wait for companies to lower their forecasts and then follow suit. The issue is that when those analysts eventually revise their outlooks to reflect the economic reality around them, no matter how much the market may have fallen or risen, it will be that much more expensive.

As we exit the week, market chatter points to many waiting for Federal Reserve Chairman Ben S. Bernanke to speak at the Jackson Hole, Wyo. gathering of central bankers. While some are hoping for a third round of stimulus, to me that is more likely to be a “buy the rumor, sell the news” moment. More as it develops.

Chris Versace, the Thematic Investor, is director of research at Think 20/20, an independent equity-research and corporate-access firm in the Washington, D.C., area. He can be reached at cversace@washingtontimes.com. At the time of publication, Mr. Versace had no positions in companies mentioned; however, positions can change.

About the Author
Chris Versace

Chris Versace

Chris Versace, the “Thematic Investor,” is the director of research at Think 20/20, an independent equity research and corporate access firm located in the Washington, D.C. area. Before Think 20/20, Mr. Versace was the portfolio manager of Agile Capital Management (ACM), a thematically driven alternative investment fund. The groundwork for ACM was laid during Mr. Versace’s tenure as senior vice president of equity ...

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