For months, analysts who write reports praising or panning stocks have been saying they were cheap. Investors were unconvinced, buying one day, selling the next. Last week, they mostly sold, and stocks got cheaper yet.
The Dow Jones industrial average rose slightly Friday but closed the week down 6.4 percent, its worst showing since the depths of the financial crisis three years ago. In the broader Standard & Poor’s 500, the selling pushed down all variety of stocks – sexy high techs and staid utilities, risky small companies and cash-rich big ones.
Stock prices compared to expected profits are now nearly as low as they were in March 2009, a 12-year nadir that marked the beginning of one of the greatest bull markets in history.
Have investors sold too much, as they did back then?
Who’s right – or who’s about to play the fool – may turn on earnings, or rather, analysts’ estimates of how fast they will grow.
Recently, they’ve been cutting them for companies in the S&P 500 as fears of another recession spread. But they’re still predicting they will earn 13 percent more earnings in the three months through September than they did in the same period a year ago, according to data provider FactSet.
One ominous sign: Those who changed their estimates this month chose to cut them more than six out of 10 times, according to Citigroup. Early last month, raised estimates outnumbered lowered ones by nearly the same ratio.
But it’s worth remembering that it’s been the naysayers, the investors, and not the optimistic analysts, who’ve mostly been wrong lately.
At the start of the bull market, investors worried that companies couldn’t generate enough profits in such an anemic economy. Then companies cut expenses to the bone, and profits soared. Investors next worried that companies wouldn’t be able to sell more, and that profits were bound to fall. And then companies defied expectations again with higher revenue, much of it overseas.
At Friday’s close, the S&P 500 was trading at 10.6 times analyst estimates for earnings over the next 12 months. That’s low for this so-called earnings multiple, which could mean stocks are cheap.
When stocks bottomed on March 9, 2009, they were trading at 10.4 times estimated earnings. The 10-year average is 15.
Of course, the multiple might not look so appetizing in hindsight if companies’ results show the estimates were too high.
That won’t be clear at least for another two weeks, when companies start reporting third-quarter results.