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August 25, 2010 at 08:00 PM
Analysts always find reasons why stocks should be going up. “But their track record shouldn’t give anyone confidence” states a recent Associated Press article.
New research from the consulting firm McKinsey & Co. found analysts tend to be overoptimistic, slow to revise their forecasts and prone to making inaccurate predictions.”
Regardless, the financial media distributes analyst predications and estimates often based on flawed assumptions. In this article, we’ll address two myths the analyst community likes to refer to:
Myth #1: Stocks are Cheap
Even though the economy is in the worst shape since the Great Depression, economists at large believe that stocks are cheap. In fact, with the S&P trading above 1,200, analysts claim that stocks are the cheapest since 1990 (Bloomberg, April 26, 2010).
Quite to the contrary, on April 16, in no uncertain terms, the ETF Profit Strategy Newsletter stated: “at current earnings, prices and dividend yields, stocks are not cheap. The message conveyed by the composite bullishness is unmistakably bearish. The pieces are in place for a major decline.”
If stocks were cheap at S&P 1,200, they must be dirt-cheap at S&P 1,100. Cheap based on what assumption though?
Based on analysts’ projections, earnings for the S&P 500 are to reach an all-time high in 2011, surpassing even the 2006 peak. Since earnings make up half of the price/earnings (P/E) ratio, stocks appear cheap based on record projected earnings. The key word is “projected.”
Looking at data from the last 25 years, research from the consulting firm McKinsey & Co. found analysts have estimated annual earnings growth to be about 10-12 percent for the S&P. Actual growth has only been about 6%. Keep in mind that the past 25 years housed the biggest bull market in American history.
Myth #2: Cash on the Sidelines Will Drive Stocks Higher
Cash on the sideline is viewed as bullish because, theoretically, it can be used to buy stocks and drive up prices. Some distinguish between corporate cash and retail cash on the sidelines.
Many forget that for every dollar in cash, there is a debt that has to be repaid. According to the Federal Reserve, nonfinancial firms’ debt totals $7.2 trillion, the highest level ever.
As far as retail investors go, the current debt-income ratio is at 126 percent. The pre-bubble average was around 70 percent. To get back to the pre-bubble norm, about $6 trillion worth of debt would have to be eliminated.
Retail money in money-market funds is currently around the same level as it was in 2006-2007. Is that bullish?
Unlike Wall Street and the financial media, the ETF Profit Strategy Newsletter takes an out-of-the-box approach to market analysis, which tends to be contrary to both popular analyst opinion and thus more reliable.
