Stock Market Warning Siren Is Blaring

Tyler Durden's picture

Authored by Wolf Richter via,

Are we blinded yet by the brilliance of corporate earnings?

“Adjusted” earnings growth is 10.2% year-over-year in the second quarter, according to FactSet, based on the 91% of the companies in the S&P 500 that have reported results. The energy sector was a key driver, with 332% “adjusted” earnings growth from the oil-bust levels of a year ago.

The sectors with double-digit earnings growth: information technology (14.7%), utilities (10.8%), and financials (10.3%). The rest were single digit. Earnings in the consumer discretionary sector declined.

Revenues grew 5.1%, also led by the energy sector. At the beginning of Q2 last year, the WTI grade of crude oil traded at $35 a barrel. In Q2 this year, WTI ranged from $42 to $53 a barrel.

So the Wall-Street hype machine is cranking at maximum RPM to propagate the great news that earnings are soaring, and that this is the reason why stocks should also be soaring, and forget everything else. The hype machine carefully avoids showing the bigger picture which is dismal for earnings and ludicrous for stock valuations.

Aggregate earnings per share (EPS) for the S&P 500 companies on a trailing 12-months basis rose for the second quarter in a row.


That’s the foundation of the Wall Street hype.


But here’s the thing with these EPS: they’re now back where they had been in… May 2014.

Yep. More than three years of earnings stagnation. No growth whatsoever, even for “adjusted” earnings. In fact, on a trailing 12-month basis, aggregate EPS of the S&P 500 companies are down about 5% from their peak in Q4 2014. And yet, over the same three-plus years of total earnings stagnation, the S&P 500 index has soared 34%.

This chart shows those “adjusted” earnings per share for the S&P 500 companies (black line) and the S&P 500 index (blue line). Chart via FactSet (click to enlarge). I marked August 2012 as the point five years ago, and May 2014:

And these are not earnings under the Generally Accepted Accounting Principles (GAAP). FactSet uses “adjusted” earnings for its analyses. These are the earnings with the bad stuff “adjusted” out of them by management to manipulate earnings into the most favorable light. Not all companies report “adjusted” earnings. Some only report GAAP earnings and live with the consequences. But others put adjusted earnings into the foreground, and that’s what Wall Street dishes up.

Since August 2012, the trailing 12-month “adjusted” earnings per share of the companies in the S&P 500 index rose just 12% in total. About the rate of inflation – nothing more. Over the same five years, the S&P 500 Index soared 72%.

And there’s another thing: these earnings per share are heavily influenced by the share count. Companies have been on a huge borrowing binge over these years, fueled by historically low interest rates, and a big part of that borrowed money wasn’t used to create new things, expand, invest, or invent, but to buy back their own shares. This type of financial engineering lowered the share count, and thus artificially increased earnings per share. Growth in EPS due to financial engineering is fake earnings growth.

This is the peculiar situation of today: On average, these companies have stagnating earnings per share propped up by “adjusting” these earnings and by financial engineering. The price-earnings multiple (P/E ratio) for stagnating companies should be low. In January 2012, the P/E ratio for the companies in the S&P 500 index was 14.9. And that was high. As of Friday, the aggregate P/E ratio is 24.3:

But look what happened. The P/E ratio peaked in March at 26.6. Since then, the S&P 500 has ticked up 3% and earnings have risen to this glorious level Wall Street has been hyping and the P/E ratio has come down a wee tiny bit…. back to where it had been in the fall of 2016.

In the five-year picture, earnings per share – however doctored they’d been – expanded just 12%. But share prices skyrocketed 73%. And thus the P/E ratio soared. These phases of “multiple expansion” are part of the stock market’s boom and bust cycle. They’re invariably followed by periods of multiple contraction.

Multiple contraction doesn’t stop at the average long-run P/E ratio but falls far below it, because that’s how the long-run average P/E ratio is formed: by periods far above the average (right now) and by periods far below the average. In the past, this type of multiple contraction from the top of the range to the lower end of the range – the process of “reversion to the mean” – offered some hair-raising rides for the stock market overall and for ludicrously overvalued stocks in particular, with many money-losing companies not making it to the next phase.

No one knows the date when this process kicks off in earnest, though everyone wants to know it so they can scurry out of the way beforehand. But when enough folks are trying to scurry out of the way, they’ll will precipitate the beginning of that process. That’s always how it happens.

The last big enthusiastic buyer, China, is leaving the party. Read…  This Hits the Wheezing Commercial Real Estate Bubble at Worst Possible Time

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silverer's picture

I thought they gave up those sirens in the early 60's? Aside from that, I see another 10% on the earnings upside, because investors are that stupid. Apple alone would probably jump 20 points if they started a rumor of easily replaceable iPhone batteries.

The_Juggernaut's picture

Prices will rise until the free money stops flowing.  That's all.

Creepy_Azz_Crackaah's picture

Warning blaring again?!?!? Didn't I see this article last year? And the year before? And the year before that? And the year before...

Caloot's picture

The sirens have been blaring for ten years.  

order66's picture

It's really not though. They're still printing with no sign of stopping.

Overleveraged_and_Impatient's picture

LOL enough. Please. If today didn't set everyone straight about the true mechanism of the stock market I don't know what will. On any given day, the Fed and SNB inject BILLIONS of dollars at 3 AM Eastern, or between 9 - 11 AM estern. And on these injection days, the President's Working Group on financial markets very closely monitors trading and fills in the gap with more injections everytime a normal person sells shares.

Folks, this is not rocket science. They will inflate this market as much as necessary as the savings accounts of ALL baby boomers literally depends on it. Social Sec is going broke. They KNOW that the only chance to avoid massive starvation is to pump up the Stock Market.

Folks, the value of your dollar may go down, but hte S&P 500 will hit 4500 by Q1 2019. There is simply too much at stake. We're talking an entire retiring generation that will starve to death if the stock market crashse. They will destroy the dollar before the stock market crashes. 

I suggest buying 3x Long leveraged S&P 500 to take full advantage of this situation we've found ourselves in. More Injections, more gains. Get on the train!!!!!

nope-1004's picture

I totally agree.  The "markets" aren't allowed to fall, it's Fed policy #1.  Banks as well aren't allowed to show their true financial state.

The problem with your thinking though is it's like homes on the way up in price:  Buying is easy, but getting out when it's toppy or even starts to fall - not so much.  So your thinking is correct in that it's a manipulated joke, but I wouldn't want to be one heading for the exits when she derails.

Nature has a funny way of whipping back when pulled too far away from the normal.


Iconoclast421's picture

lol there can be an argument for 2900 by Q1 2019, but 4500? Now that's some crack you smokin. You should buy some SPY 350 Jan 2019 calls. They are only about $10 a contract, and if that kind of rally comes to pass at any point in the next 16 months, those contracts will be worth as much as $20000 each.

OCnStiggs's picture

They'll control it until they lose control. But the current "melt-up" could see the DJIA at 60,000 or 80,000 by the time they completely lose control and their contributions are far too small to have an effect.

I agree with you. Until then, they will do whatever it takes to keep the cocain-powered insane clown posse circus train disaster headed upward. Then, look out.

My money is literally on the idea that: As long as more equity prices increase than decrease, this market is still viable. When the majority of stocks are in decline, time to pull the handles and bail. This means the magic no-workie no-mo and major wreckage is right around the corner.

ChimiBonga's picture

"We make money the old fashioned way,

We BURN it."

buzzsaw99's picture

just non gaap the earnings and problem solved.

Hikikomori's picture

"It's all rigged, I tell you - that is why I've lost money on my investments all my life!" - any ZH poster ever.

KimAsa's picture

But. . . the algos

Fake Trump's picture

Crash  the markets. 

BingoBoggins's picture

Fuck! Stuck in this backwater town ... I had no warning!!

I see white people ... they're everywhere ... I can't move my legs .... Oh, lawdy, i declare!!!

wholy1's picture

corps "cooking books" to "appear" earnings are strong since the "Fraud Preserve" (Fed) started putting the squeeze on liquidity/lending previously going to corp CEO/Board stock buy-backs?

Ben A Drill's picture

It's the Great Gastby all over again.

Greenspazm's picture

Fuck the stock market, nothing matters except Bitcoin. Satoshi his making his disciples rich beyond their wildest dreams.

OCnStiggs's picture

Are you rich beyond your wildest dreams? Why not? Whats holding you back?

Chairman Meow's picture

What the "ignorant" don't understand is that they can use high-level policy and infallible technology to control and secure the system. Just like Jurrasic Park. 

Nobody For President's picture

As soon ad you say, or write, or think 'stock market' you are on the wrong set of rails.

It ain't no 'market' any more.

I started investing in 1964, as soon as I got out of the Army, and it was a market.

It ain't no more.

No way.

No how.

I can put in a bid or ask maybe once in 10 seconds.

Any HFT worth it's salt can put in ~7000 in one second.

60%^ + of market trades today are computer - and a bunch more trades are off-market dark pools.

It ain't a market any more. 

It is a "market".

Forget that at your own peril, but stop pretending there is such a thing as a stock market (without the quotes).

ZH used to be pretty good about pointing this out with concrete examples, but those days appear to be gone. Alas.