Sunday, January 15, 2012

Earnings Expectations Remain Incongruously High

I've noted that one significant impediment to higher stock prices in the U.S. has been the high expectations for profit growth in 2012.  Though the consensus forecast for S & P 500 earnings has been trending lower, 2012 profits are still expected to be more than 10% above 2011 levels.  This seems to be a stretch given that Europe is in recession, China and other developing economies are slowing, and profit margins in the U.S. are at historically high levels.

Even more surprising is the consensus estimate of 9% profit growth in Europe this year.  With the continent in recession and headline risk extraordinarily high, one would expect greater caution among analysts.  Valuations of European equities are quite depressed, but a major shortfall in profits would impede gains in share prices.  There are, however, a number of European companies that are global leaders and whose shares are increasingly attractive.  

I think a major surprise in 2012 could be gains in the Euro and European stock prices.  If Greece and other weak members are forced out, the Euro would become stronger and more like the Deutsche Mark.  That assumes that the banking system survives.

Contrarians take note.  The percentage of bulls on the Euro in the latest Consensus Inc. poll was only about 15%.  In addition, long positions in the U.S. dollar were among the highest in the last five years.  A lot of bad news is priced into the market.  

But before acting on either of those contrarian trades, I want to see more realistic profit estimates in Europe, and further declines in the Euro, first.

Steve Lehman

S & P 500:  1295

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