Over the weekend, I got a few tweets talking about some technical analysis currently being passed around the Internet suggesting the S&P 500 is about to make a significant move towards 2400. While anything is certainly possible, the problem with the analysis is the lack of fundamental underpinnings to support such a move higher, namely, economic growth and corporate profitability.
Of course, the issue ultimately comes down to valuations. At a price of 2400, based on current earnings per share of $86.92, the market would be trading at the second highest level of valuations in history with a P/E of 27.61.
However, as I was tweeted yesterday morning:
However, in Paolo’s attempt to justify the bullish meme, the forward earnings estimate is no longer $133/share but, according to S&P, just $122.15 through the end of 2017. IF we assume those estimates are correct, now the forward P/E rises to 19.64x earnings. Certainly not cheap.
But even those estimates are a likely a fantasy. Throughout history, earnings are consistently overstated by roughly 33%. This overstatement of estimates can be clearly seen in the chart below.
If we held Wall Street analysts to their estimates at the beginning of this year, much less the beginning of the previous quarter, 100% of companies would have missed earnings during the second quarter of this year. In fact, in just the past three months, analysts have now ratcheted down their estimates for the third quarter to their lowest levels yet.
In other words, in order for companies to win the “beat the estimate game,” they need the bar lowered far enough to ensure they can clear it.
The problem is actually worse than just Wall Street analysts consistently lowering earnings estimates to make company reports look better, corporations themselves have been using four primary tools to boost earnings per share as well.