Down, Then Up from today's Barrons
But has the market discounted a 2002 earnings recovery
By Erin E. Arvedlund
Looking across the valley is in vogue on Wall Street these
days. All but writing off the dreadful fourth-quarter profits due
to be released in a few weeks, the stock market expects a robust
earnings rebound in 2002 and 2003, which is being manifested in
the rousing rally that has pushed the Dow Jones Industrial
Average back over the 10,000-point mark.
But the key question, posed by Morgan Stanley economist
Richard Berner, is: "Will economic recovery bring with it the
cyclical rebound in corporate profits that is now discounted in
stock prices?" Securities analysts confidently answer yes,
projecting a 14% rebound in 2002 operating earnings for the
Standard & Poor's 500, which the buoyant stock market seems
to second. (Berner looks for a more modest 8% gain.)
Blithely dismissing the current quarter's awful results may not be
wise. "The fourth quarter is going to be a disaster, just a terrible
quarter, although you could interpret that as positive because
things are starting to bottom out," says Chuck Hill, director of
research at Thomson Financial's First Call. "What really
concerns us is that there is no sign of deceleration in earnings
warnings" and preannouncements, he adds.
As of Friday, 456 companies had warned about fourth-quarter
earnings, compared with 426 at the equivalent point in the first
quarter, 433 in the second quarter and 403 in the third this year.
First Call estimates fourth-quarter earnings will slide as much as
19% from last year, with about 5% of that decline relating to the
September 11 terrorist attacks. That would put the the S&P 500
earnings at $11.05 in the current quarter, up a few pennies from
the estimate of the previous period (a few stragglers haven't
reported their September-quarter results). That also would bring
this year's total to $45.10, down from $55.12 in 2000.
Noting the great expectations of an earnings revival in the second
half of 2002, Hill is wary: "We haven't had any visibility that far
out during the downturn."
In the fourth quarter, the worst S&P sector is likely to be the
transports, owing to airlines' massive losses after September 11.
Technology profits are estimated to be down 62%, despite Cisco
Systems last week painting itself as a bright point in a dark
sector. With a recession officially declared, earnings of such
cyclicals as basic materials (paper, metals, chemicals) are seen
down 54%. The slide in oil prices is expected to slash energy
earnings 49% from those of a year ago. Consumer cyclical
earnings are forecast to be off 22% as automakers' 0% financing
wars cost dearly. Ford Motor last week warned it would lose 50
cents per share, a wider deficit than the 14 cents the Street had
forecast and the 28 cents posted in the third quarter. Finally,
communications earnings are projected to decline 20% and
capital-goods profits are forecast to fall 10%.
On the positive side, consumer-staples concerns' earnings are
estimated to increase 5%. Utilities could jump 9% and produce
some upside surprises, particularly since embattled Enron's
numbers won't be included because the company has been
booted from the S&P 500. Health-care earnings are projected to
grow 13%, and financials to rise 10%, although exposure to
Enron could hurt some banks and brokerage firms.
But if Wall Street so confidently sees a recovery in profits next
year, doesn't that mean a rebound is discounted in the market,
especially with the S&P up 20% since the September 21 lows?
For JP Morgan Private Bank strategist Chris Wolfe, so far the
answer is yes. "We think stocks will likely move sideways next
year." The expected recovery "is baked in, in large measure. The
market's a bit expensive here."
Other strategists aver that next year's recovery hasn't been fully
discounted. Bill Knapp, Citigroup Asset Management's head of
global investment strategy, says stocks have still further to go in
2002. "Back in August, equities were a good value. The events
of September 11 just exacerbated the trough in the economy, but
on the other side we'll see a higher high" when the economy
recovers in the third quarter of 2002.
He and his colleague Paul Goldwhite, Citigroup's co-head of
capital markets research, see stocks returning 10%-15% next
year, followed by returns in the high single digits over the next
five to 10 years. Like the Street, they're optimistic about
financials, Information Technology and telecommunications
services, although they see IT earnings growth at a more
sanguine mid-teens percentage level. "It is not clear IT budgets
will recover as quickly as the Street wants them to," Knapp says.
"It's the old malady of already having inflated expectations."
Peering still farther out over the earnings valley, Salomon Smith
Barney strategist Tobias Levkovich last week reinstated an S&P
500 preliminary earnings estimate of $54 for 2003. While the
S&P currently trades at a seemly expensive price/earnings
multiple of 25.2 times estimated 2001 earnings, it commands
only 21.2 times his current 2003 estimate, which "is far more
reasonable, especially against a backdrop of modest inflation and
moderate interest-rate levels."
Easton Ragsdale, associate head of equities at State Street
Research & Management, points out that high P/Es aren't
meaningful during periods of trough earnings. "If you accept the
argument -- and I do -- that low interest rates explain why we
have such high P/Es, it looks a lot less like a bubble than it did a
year ago." |
