During the month of October, three things happened that destroy any credibility that 'believers' had about the stock 'market' being an efficient discounter of fundamental earnings. Stocks began the month weak on geopolitical fears, concerns about the end of QE, and falling earnings; then Bullard unleashed his "but but but we might do QE4" words and stocks exploded higher. But a funny third thing happened as this malarkey occurred... analysts kept on slashing EPS estimates - in fact they slashed them by more than double the average EPS downgrade of any quarter in the last 10 years... So, if earnings are the mother's milk of the market, central bank promises are the Human Growth Hormone, EPO, Steroid cycle of all-time highs.
Fundamentals or Central Bank liquidity!
During the month of October, analysts lowered earnings estimates for companies in the S&P 500 for the fourth quarter. The Q4 bottom-up EPS estimate (which is an aggregation of the estimates for all the companies in the index) dropped by 2.7% (to $30.96 from $31.82) during the month. How significant is a 2.7% decline in the bottom-up EPS estimate during the first month of the quarter? How does this decrease compare to recent quarters?
During the past year (4 quarters), the average decline in the bottom-up EPS estimate during the first month of the quarter has been 1.3%. During the past five years (20 quarters), the average decline in the bottom-up EPS estimate during the first month of the quarter has been 0.6%. During the past ten years, (40 quarters), the average decline in the bottom-up EPS estimate during the first month of the quarter has been 1.8%. Thus, the decline in the bottom-up EPS estimate recorded during the course of the first month (October) of the fourth quarter was higher than the 1-year, 5-year, and 10-year averages.
However, most of the reductions to earnings estimates have occurred in the commodity-based sectors. As noted in last week’s report, the Energy sector (-10.8%) has recorded the largest decline of all ten sectors in terms of bottom-up EPS, followed by the Materials sector (-7.5%). No other sector has recorded a decrease in bottom-up EPS of greater than 3.3% through the first month of the quarter.
In terms of price, the value of the S&P 500 has increased by 1.1% (to 1994.65 from 1972.29) during the month of October. This marks the 7th time in the past 12 quarters that the bottom-up EPS estimate has decreased while the price of the index has increased during the first month of the quarter.
