I'm not bearish.
I really think the US economy is coming out of its slumber. Most of the signs are pretty good.
The problem is I don't trust the market.
After such a big run over the last year, I can see the market continuing higher. With a little bit of earnings growth (9% projected this year...which could be a stretch, but maybe it isn't) and a little more multiple expansion (say from 15.5x to 18x) the market could easily deliver another 26% return - and even then would not be overly valued. I find myself making these rationalizations. It is easy to do.
The problem is the higher it goes, the less margin for error there is and the more I don't trust it.
When you know you are playing a con(fidence) game, you are always looking to be the first to exit the party (which can make for some bad - kneejerk - decisions).
Showing posts with label earnings. Show all posts
Showing posts with label earnings. Show all posts
Tuesday, January 14, 2014
Wednesday, October 30, 2013
What Drives Equities
Over the long term equities are driven by two things. One, fundamental and the other sentimental.
The Fundamental
The fundamental driver of equities values is earnings. Earnings are a function of revenues (demand), margins (efficiency) and tax regimes. Earnings may vary over time, but trend positive.
The Sentimental
The sentimental driver of equities values (which is to some extent and at different times more important than earnings) is the multiple. What the market is prepared to pay for earnings at any particular point in time. It is a function of confidence and risk. The multiple the market is prepared to pay for present (and implied future earnings) varies from a high of 35x to a low of 8x.
Since bottoming in 2009 the market has been propelled by substantial earnings recovery and earnings growth ($30 EPS to $115 EPS), and by multiple expansion (11x to 16x). With earnings plateauing, future market performance is likely a function of multiple performance. If the multiple goes from the present 16x to 20x then the market can rise to 2300 (30% above the present level). Projecting earnings is relatively easy (or if not easy, more stable). Projecting multiples is a lot more difficult.
The Fundamental
The fundamental driver of equities values is earnings. Earnings are a function of revenues (demand), margins (efficiency) and tax regimes. Earnings may vary over time, but trend positive.
The Sentimental
The sentimental driver of equities values (which is to some extent and at different times more important than earnings) is the multiple. What the market is prepared to pay for earnings at any particular point in time. It is a function of confidence and risk. The multiple the market is prepared to pay for present (and implied future earnings) varies from a high of 35x to a low of 8x.
Since bottoming in 2009 the market has been propelled by substantial earnings recovery and earnings growth ($30 EPS to $115 EPS), and by multiple expansion (11x to 16x). With earnings plateauing, future market performance is likely a function of multiple performance. If the multiple goes from the present 16x to 20x then the market can rise to 2300 (30% above the present level). Projecting earnings is relatively easy (or if not easy, more stable). Projecting multiples is a lot more difficult.
Thursday, February 4, 2010
Disconnect
We're seeing signs of a disconnect.
General economic trends are moving in the right direction, earnings are coming through better than expected.
And yet, the market is getting sold!
Welcome to a balance sheet recession.
We have hollowed out core economic institutions (bankrupt state governments, overleveraged consumer, increasing financial risk on the sovereign) which mean bombs can go off anytime (after all it is a confidence game) and there is less margin for error.
Greater market volatility likely to ensue.
General economic trends are moving in the right direction, earnings are coming through better than expected.
And yet, the market is getting sold!
Welcome to a balance sheet recession.
We have hollowed out core economic institutions (bankrupt state governments, overleveraged consumer, increasing financial risk on the sovereign) which mean bombs can go off anytime (after all it is a confidence game) and there is less margin for error.
Greater market volatility likely to ensue.
Wednesday, August 5, 2009
Why The Big Beats?
Company earnings are coming in way above consensus expectations. Why the many, and why the big beats?
Couple of thoughts. (1) When the economy was in freefall nobody had any clue what the future looked like. In the panic that followed, companies erred on the downside and set us up for the current round of big beats [managed expectations]. (2) It appears that companies have a lot less operating leverage than we give them credit for [earnings have fallen less than topline declines would imply]. (3) We are borrowing earnings from the future to win in the present [accounting manipulation]. (4) Companies were pretty quick on the trigger to fire workers [lots of fat in the system].
Several implications. Analysts are playing catch-up by raising forward estimates, but they'll soon be getting closer to reality, and that means the lowered expectations game will be tougher to play ["we're onto you"]. If it was too much fat in the system, then we are likely stuck with high level structural unemployment [dead weight costs to economy and one-off gains for company earnings]. If it was simply management hitting the panic button, then we are on the mend [operating leverage will propel future earnings but be counterbalanced by rehiring costs...highlights the short sightedness of some managements]. As far as I am concerned, management is always suspect with regard to their accounting policies, assumptions and treatments, and their attempt to manage and massage earnings [that is a gross generalization, but probably not far from the truth]. This time is no different, and it will be interesting to see how and where they try to manage earnings going forward [lots of moving parts on this one].
Couple of thoughts. (1) When the economy was in freefall nobody had any clue what the future looked like. In the panic that followed, companies erred on the downside and set us up for the current round of big beats [managed expectations]. (2) It appears that companies have a lot less operating leverage than we give them credit for [earnings have fallen less than topline declines would imply]. (3) We are borrowing earnings from the future to win in the present [accounting manipulation]. (4) Companies were pretty quick on the trigger to fire workers [lots of fat in the system].
Several implications. Analysts are playing catch-up by raising forward estimates, but they'll soon be getting closer to reality, and that means the lowered expectations game will be tougher to play ["we're onto you"]. If it was too much fat in the system, then we are likely stuck with high level structural unemployment [dead weight costs to economy and one-off gains for company earnings]. If it was simply management hitting the panic button, then we are on the mend [operating leverage will propel future earnings but be counterbalanced by rehiring costs...highlights the short sightedness of some managements]. As far as I am concerned, management is always suspect with regard to their accounting policies, assumptions and treatments, and their attempt to manage and massage earnings [that is a gross generalization, but probably not far from the truth]. This time is no different, and it will be interesting to see how and where they try to manage earnings going forward [lots of moving parts on this one].
Wednesday, May 6, 2009
1Q Earnings - A sign of hope
1Q09 earnings are providing a ray of hope.
Earnings are coming in better than expected (no surprise). But the downward revisions are slowing, pointing to a potential bottom in the earnings revision cycle.
This is important, because analyst estimates (which simply mirror management guidance) are generally lagging. And so, much in the same way that analyst estimates are behind the curve on the way up in the earnings/economic cycle, they have been behind the curve on the way down. This playing catch-up, usually meets at the top and the bottom of the earnings cycle.
Earnings are coming in better than expected (no surprise). But the downward revisions are slowing, pointing to a potential bottom in the earnings revision cycle.
This is important, because analyst estimates (which simply mirror management guidance) are generally lagging. And so, much in the same way that analyst estimates are behind the curve on the way up in the earnings/economic cycle, they have been behind the curve on the way down. This playing catch-up, usually meets at the top and the bottom of the earnings cycle.
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