Earnings Forecasts Drive Stocks, Not Earnings

The Bear’s bear, David Rosenberg, opines that it is not earnings but changes in earnings expectations that drives the market:

[T]he peak in earnings forecasts coincided with the peak in the market [in April].

And guess what? The forecast peak in the last cycle was in October 2007, again right when the S&P 500 was hitting its highs. Before that, earnings estimates were starting to get cut in August 2000, just ahead of the peak in the market.

In Ahead of the Tape this morning, the WSJ supported this point of view. Q2 earnings were strong across the S&P: up 38%, well above the expected 27% YoY increase. Yet the market is dropping – and began to fall just as earnings forecasts began to be revised downward for 2011 (see chart). 2011 earnings estimates started in January at 25% growth, were reduced to 20% in April, and now are hovering at under 15%. The change of view:

[T]allies with the outlook for broader economic growth, which has weakened considerably.

Even the 15% prediction may be revised downward, as it is nearly triple the expected GDP growth for 2011, which itself is being revised downward. Goldman this morning is urging analysts to cut GDP estimates even further, to the range of 1.5% in 2H10 and early 2011. Yet as recently as the last week of June, before the poor GDP report, the WSJ was touting only modest decrease in earnings expectations:

At the time earnings were expected to rise in the second half of 2010. No longer.

We may be at “Peak Earnings“:

If the macro economic data continues to disappoint to the downside (as JP Morgan suggests) then it’s clear that analysts have been fooled into believing that the stimulus and 80% rally are self sustaining.

Clearly analysts have not yet fully embraced the economic slowdown. Why not? Using an expectations model from The Pragmatic Capitalist, they may have overshot mean reversion on expectations too much to the positive, and are due for a double dip there, too:

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About Duncan Davidson 228 Articles

Affiliation: NetService Ventures

Duncan is an advisor to NetService Ventures, where he focuses on digital media and the mobile Internet.

Previously he was at four start-ups: Xumii, a mobile social service based on a Social Addressbook; SkyPilot Networks, the performance leader of wireless mesh systems for last-mile access, where he was the founding CEO; Covad Communications (Amex: DVW, $9B market cap at the peak), the leading independent DSL access provider, where he was the founding Chairman; InterTrust Technologies ($9B market cap at the peak), the pioneer in digital rights management technologies, now owned by Sony and Philips, where he was SVP Business Development and the pitchman for the IPO.

Before these ventures, Duncan was a partner at Cambridge Venture Partners, an early-stage venture firm, and managing partner of Gemini McKenna, a joint venture between Regis McKenna's marketing firm and Gemini Consulting, the global management consulting arm of Cap Gemini.

He serves on the board or is an adviser to Aggregate Knowledge (content discovery), Livescribe (digital pen), AllVoices (citizen journalism), Xumii (mobile social addressbook), Verismo (Internet settop box), and Widevine (DRM for IPTV).

Visit: Duncan Davidson's Blogs

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