Poor Earnings Could Depress Stocks

05/14/2009 1:00 pm EST

Focus: MARKETS

Gary Shilling

Columnist, Forbes

Gary Shilling, editor of INSIGHT, says earnings will be weaker than many expect, and that could keep stock prices down.

Corporate profits last year were simply dreadful. The pre-tax profits, using the Commerce Department definition, fell $250 billion at annual rates, or 16.5%, in the fourth quarter from the third quarter—the steepest decline in 55 years—and 21.5% from a year earlier. For the year, profits were down 10.1%.

Standard & Poor’s 500 operating earnings, which are much closer to Commerce Dept. profits, fell 40% from 2007 to $49.51 in 2008. S&P 500 operating earnings last year fell much more than corporate profits in the past largely because of the huge losses of large banks that dominated the financial sector of that index.

The $40 for S&P 500 operating earnings for 2009 that we forecast last November looks more and more likely, given our forecast that the worst financial crisis and deepest recession since the Great Depression will last throughout the year and into 2010.

That forecast generated a lot of shock and interest at the time, and ever since, especially after the disastrous fourth-quarter numbers became available. Even more so because after applying a 15x P/E, which is optimistic for stock market bottoms, even with current low interest rates, the implied low for the S&P 500 index is 600, a 32% drop from the current levels and 61% below its record close on October 9, 2007.

Furthermore, our numbers were and still remain distinctly lower than the averages of Wall Street seers. Last September, analysts collectively forecast $103.85 per share for 2009 S&P 500 operating earnings. By November, when we made our $40 forecast, they dropped their estimates to $89.83 and then to $81.80 in December. Still, that was an amazing increase from the $65.79 they expected in 2008.

We haven’t revised our $40 estimate a penny, but after the disastrous fourth quarter, Wall Street wizards have slashed their estimates further. Now, bottom-up analysts look for $59.20 for S&P 500 operating earnings this year, but still up 20% from 2008’s final $49.51 per share. And that's after they reduced their first-quarter earnings estimate vs. a year ago from the 26% increase forecast last October to a 22% drop.

Top-down strategists foresee $44.41 for 2009 as a whole, a 10% decline from 2008. Still, these numbers, especially the bottom-up estimates, are considerably above ours.

Why the differences? As was the case last fall, it’s probably partly because Wall Street forecasters are perennial optimists. Furthermore, Wall Street analysts believe the S&P 500 financial sector’s loss of $130 billion last year will be replaced by $63 billion in gains this year.

In the first quarter, those analysts collectively expect financial earnings to rise 2% year-over-year, but earnings in the industrial sector to fall 38%. In contrast, we believe the financial sector may stabilize this year but not rebound much. We see the serious global recession and financial mess lasting into 2010, but most others expect the financial sector to stabilize and the economy to recover in the second half of this year.

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