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May 02, 2011 at 10:18 PM
Look at price charts and you'll see that stocks are loved. Look at the VIX and you'll see that stocks are carelessly loved.
Careless love is reflected in a recent Bloomberg article, which identified the most explosive profit growth in the past century. This profit explosion is happening right here, right now. As per this article, now is not the time to be selling stocks because they are cheap.
Careless love often results in unwanted consequences, so we do well to examine the “stocks are cheap” assertion. According to Bloomberg, “The gap between projected 12-month profits and average earnings over the last 10 years is set to widen the most since 1951.” Projected earnings are expected to clock in at a record $91 for S&P 500 companies.
Before you trigger the “buy everything now” button, think about the above statement for a second. If the gap between projected profits and average earnings is the biggest since 1951, it means that it’s bigger than in 2000 and 2007, which noted major market tops and were followed by sizeable declines.
If you graph this out, you would see three spikes; one pop in 2000, one in 2007 and one now. Every time the spread spiked to new highs, stocks fell hard. Keep in mind that the spread is based on projected earnings. Projected earnings are about as certain as a politician’s promise.
How accurate are analysts’ and earnings projections? Days before the March 2009 low, Goldman lowered its earnings outlook for the S&P from $113 incrementally to $40. Bank of America Merrill Lynch lowered its estimate to $46 and Citigroup lowered to $51. At the same time – on March 2, 2009 – the ETF Profit Strategy Newsletter sent out a special buy alert and recommended loading up on stocks.
Analysts tend to be overly bullish at market tops just as they are overly bearish at market bottoms. Based on Standard & Poor’s data, earnings actually peaked at $87 in 2006 and never reached Goldman’s projected upside target of $113. Earnings also bottomed before they reached Goldman’s projected down side target of $40.
