Expectations in investing--as in life--are crucial to satisfactory outcomes. Low expectations in investing tend to result in high returns, as people are pessimistic or cautious about prospective returns (or the economy, or corporate earnings) and are more likely to be pleasantly surprised. Earnings expectations are particularly important, because it is surprises--positive or negative--that tend to really drive stock prices.
One reason for my neutral position toward stocks--aside from my optimism after the sharp selloff in August and September--has been high expectations for earnings on S & P 500 companies over the coming twelve months.
At the market bottom in spring 2009, the consensus estimate for S & P 500 earnings for the coming twelve months was for earnings to decline 20%. Now those are low expectations! Going back to 1979, when consensus estimates for S & P 500 earnings have been for less than 4.2% earnings growth, the annualized return on the S & P 500 has been 17%. Conversely, when consensus estimates for earnings growth have been above 14.2% growth, the S & P has had a slightly negative return.
Consensus estimates have recently come down as economic growth forecasts for 2012 have moderated, particularly because of stagnant economic activity in Europe. The latest estimate for S & P 500 earnings for the coming twelve months is 13%, which is in the middle range that has produced average annual stock returns of 7% back to 1979.
So for economically sensitive stocks such as ABB or G.E., I've been waiting for earnings estimates to come down to more reasonable levels before buying them. The changes in consensus expectations are in the right direction. But given this week's surge in stock prices, I am neutral on stocks now.
S & P 500: 1244