Earnings command no respect in S&P Ice Age

published 7 August 2006

Robust earnings (along with reduced fears of a rate hike) helped propel US markets higher last week, with the S&P 500 posting its best weekly gain in three years. Bellwether stocks, such as ExxonMobil and AT&T, beat expectations and offset a handful of high-profile disappointments, including Amazon, which failed to break the streak of poor results from tech stocks.

But even as the market bounced, bulls complained that most firms remained heavily undervalued. "Like the late comedian Rodney Dangerfield, earnings are getting no respect," says Ed Yardeni of Oak Associates, quoted in the FT. "Many of the best earnings performers in recent months have experienced significant declines in their p/es."

But this merely continues the pattern of the last few years, as Philip Coggan points out, also in the FT. "The last six years has indeed seen a de-rating of the equity market. The prospective price/earnings ratio of the US market has fallen from 24 in 1999-2000 to below 14 today. That explains why the phenomenal profits growth by the US corporate sector has not yet resulted in the Dow reaching new highs." For bulls, that's reason to expect a market surge, as stocks re-rate back up to historic p/es. But for berbears, such as Albert Edwards of Dresdner Kleinwort, the opposite is true. His Ice Age' thesis is that the US market is locked into a long-term trend of declining p/es that could easily continue until the ratio reaches ten or lower. Factor in a possible recession which could reduce earnings by around 20% and he believes that the S&P could fall by about 40% from current levels.