Trader’s Narrative

A reader, Wayne Whaley, who is also a veteran trader and registered CTA sends in this concise report on the earnings season:

“About 1/2 of second quarter earnings are in and we have a pretty good estimate now of what final earnings should look like at the end of the quarter.

With interest rates at current levels, you can make a mathematical case for P/Es in the 25-30 range

Observations:

Including the 2009 Second Quarter Estimate of 7.27, and using 979.26 as current S&P price

1) The P/E using last 4 quarters for E is 771.07
2) The P/E using last 8 quarters annualized for E is 37.21
3) The P/E using Standard & Poors estimate for 2009 earnings as E is 32.67
4) The P/E using Standard & Poors estimate for 2010 earnings for E is 26.28
5) Earnings for the third quarter need to come in around $8.50 to avoid a negative trailing one year earnings, which from the information I have would be a first (at least in the last century).

At best, you could argue that stocks are fairly valued even using estimates for 2010 earnings. Valuation techniques are interesting to calculate and make for interesting conversation but can be misleading for market timing purposes as the market can be over (1995-2000) or underpriced (1950’s) for years, especially when earnings and money supply are moving targets.”

The chart below provides perspective on the earnings collapse by focusing on 12-month, as reported S&P 500 earnings. This quarters earnings are expected to have fallen over 98% since topping in the third quarter of 2007. That makes this, by far, the worst decline on record all the way back to 1936 - the earliest we have data. In fact, real earnings have dropped so far that in the coming quarter will see the first 12-month period where the S&P 500 earnings are actually negative!

Source: Chart of the Day

While this is certainly makes for a great story that we can tell and retell to the grandkids (boring them to tears), it doesn’t really mean much. We are at an extraordinary moment in economic history. One where we are clinging to the ledge by our fingernails and peering down at the precipice below. In such unorthodox times, orthodox measures such as the price earnings ratio can fool, rather than inform you.