Analysts' Earnings Estimates Will Push Stocks Lower

Wednesday, 26 Jun 2013 07:50 AM

By Michael Carr

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Wall Street analysts are an optimistic group of people. They believe earnings for companies that make up the Standard & Poor's 500 index will reach all-time highs this year and next year. Earnings are expected to grow 13.2 percent in 2013, compared with 2012, and then add another 12.5 percent in 2014.

Double-digit earnings growth would be a dramatic improvement from recent performance. Earnings fell about 0.6 percent in 2012 and rose 1.9 percent in 2013.

Double-digit earnings growth for the index is actually a rare event. Data provided by S&P show that there have only been three times since 1988 when year-over-year earnings grew by 10 percent or more. All three previous occasions occurred after the end of the global financial crisis that caused earnings to collapse in 2008 and 2009.

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Over the past 25 years, annual earnings growth has averaged 1.68 percent. Over the long term, we should expect to see earnings growth for the stock market as a whole that is close to the change in gross domestic product (GDP) plus inflation.

With GDP expected to be about 2 to 3 percent and inflation lower than that, double-digit earnings growth seems unlikely.

Unfortunately, the stock market is trading at about 15 times 2013 estimated earnings, a price-earnings (P/E) ratio close to the long-term average. If earnings come in lower than expected, stock prices could fall.

If earnings actually grow 3 percent, slightly faster than average, the S&P 500 should trade at about 1,500, about 8 percent below current prices.

Losses are likely to be much greater than that since markets tend to overreact to the downside when companies miss earnings estimates.

Analysts will almost certainly lower their estimates as 2013 draws to a close. They have already lowered 2013 estimates by 6.9 percent over the past 12 months. Investors should expect more downward revisions to earnings and lower stock prices as analysts bring estimates in line with history and economic realities.

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