Friday, June 10, 2011

If Analyst Estimates Are Correct, Stocks Are a Buy!

A year ago the stock market fell into a deep swoon buffeted by troubles in Greece, worries about a double-dip in the US economy, and the prognostications by many analysts that the Federal Reserve was powerless to stimulate growth.

The red line on the chart at the right shows that in 2010 the S&P 500 fell from about 1250 in April to under 1050 in June, nearly a 20% plunge.

Reading the headlines today and watching the recent activity in the stock market, one gets the feeling that we've seen this movie before. Greece is still in danger of default; economic growth in the US slowed to 1.8% in the first quarter; and the Fed has just announced that QE2 will end at the end of June.  So the obvious question is, "Are stocks headed for another 20% correction?"

We don't think so and we believe the above chart provides the best argument against a big sell off.  We explain ad nauseum that what stocks are doing in June has little correlation to what they will do for the full year.  The chart shows that stocks reversed their 2010 April-June tailspin and recovered to close over 15% higher on the year.  Those investors who sold out in the midst of all the negative blab in summer missed a terrific year for stocks.

Was there any signal last summer that told us that the stock market swoon was just noise?  Yes, analysts earnings estimates for year-end 2010 for the S&P 500, as shown by the black dashed line, never dipped.  Indeed, for most of the summer the analysts were hiking S&P 500 earnings in the face of falling stock prices.  Looking closer, the chart reveals that analysts started the year estimating that S&P 500 earnings (left scale) for the year would be about $77.  They actually ended the year at about $85.

Another clue that stocks, and for that matter the economy, were not headed for a double dip was the fact that actual reported earnings, as shown by the blue stair-step line, were moving sharply higher.

Obviously we could not have seen year-end earnings in mid 2010, but earnings in the first and second quarters were strongly and surprisingly higher.  It was clear by early July that a big earnings rebound was underway.

So where do we stand today, and what are the analysts forecasting for year-end 2011 S&P 500 earnings?  The chart at the right shows the 2011 data discussed in the first chart.

In short, the picture for mid-June 2011 is similar to mid-June 2010.  Stocks (red line) are selling off, while actual earnings (blue line), and analysts' year-end earnings estimates (black dashes) are continuing to rise.

In our judgment, the key component in this chart and in the ultimate direction of stocks is the trend of the analysts' earnings for year-end 2011.  They have risen throughout 2011 and are still trending higher.  The analysts are in close communications with the companies they cover, and if they were hearing bad news from the companies their earnings estimates would be already headed down.  We see little evidence of weakening earnings estimates among the companies we hold.

We will continue to report on the analysts' estimates for 2011 in future blogs.

This is a good time to remind our readers that we invest in global companies and not just the US economy.  Our companies produce over 60% of their earnings outside the US, with much of it coming from the fastest growing nations in the world.  We as Americans still have great difficulty conceptualizing that the US now represents only 25% of world GDP.  The global economy has become a very big place, and we no longer dominate the world's economic growth like we once did.  The good news is the world economy is growing much faster than that of the US.

If corporate earnings continue to be strong, as we believe they will, we envision that stock market activity in 2011 might turn out to be a movie that we have seen before -- down in the summer, up by year-end.