Stock Market Tsunami Siren Goes Off

Authored by Wolf Richter via,

It will be ignored until it’s too late.

Everyone who’s watching the stock market has their own reasons for their endless optimism, their doom-and-gloom visions, their bouts of anxiety that come with trying to sit on the fence until the very last moment, or their blasé attitude that nothing can go wrong because the Fed has their back. But there are some factors that are like a tsunami siren that should send inhabitants scrambling to higher ground.

Since July 2012 – so over the past five years – the trailing 12-month earnings per share of all the companies in the S&P 500 index rose just 12% in total. Or just over 2% per year on average. Or barely at the rate of inflation – nothing more.

These are not earnings under the Generally Accepted Accounting Principles (GAAP) but “adjusted earnings” as reported by companies to make their earnings look better. Not all companies report “adjusted earnings.” Some just stick to GAAP earnings and live with the consequences. But many others also report “adjusted earnings,” and that’s what Wall Street propagates. “Adjusted earnings” are earnings with the bad stuff adjusted out of them, at the will of management. They generally display earnings in the most favorable light – hence significantly higher earnings than under GAAP.

This is the most optimistic earnings number. It’s the number that data provider FactSet uses for its analyses, and these adjusted earnings seen in the most favorable light grew only a little over 2% per year on average for the S&P 500 companies over the past five years, or 12% in total.

Yet, over the same period, the S&P 500 Index itself soared 80%.

And these adjusted earnings are now back where they’d been on March 2014, with no growth whatsoever. Total stagnation, even for adjusted earnings. And yet, over the same three-plus years, the S&P 500 index has soared 33%.

This chart shows those adjusted earnings per share for all S&P 500 companies (black line) and the S&P 500 index (blue line). I marked July 2012 and March 2014 (via FactSet, click to enlarge):

Given that there has been zero earnings growth over the past three years, even under the most optimistic “adjusted earnings” scenario, and only about 2% per year on average over the past five years, the S&P 500 companies are not high-growth companies. On average, they’re stagnating companies with stagnating earnings. And the price-earnings ratio for stagnating companies should be low. In 2012 it was around 15.5. Now, as of July 7, it is nearly 26.

In other words, earnings didn’t expand. The only thing that expanded was the multiple of those earnings to the share prices – the P/E ratio. Such periods of multiple expansion are common. They’re part of the stock market’s boom and bust cycle. And they’re invariably followed by periods of multiple contraction.

How long can this period of multiple expansion go on? That’s what everyone wants to know. Projections include “forever.” But “forever” doesn’t exist in the stock market. The next segment of the cycle is a multiple contraction.

The 10-year average P/E ratio, using once again the inflated “adjusted earnings,” not earnings under GAAP, is 16.7, according to FactSet. This includes two big stock market bubbles, the one leading up to the Financial Crisis, and the current one, but it includes only one crash. This imbalance skews the results. Two complete cycles would bring the average substantially below 16.7.

Nevertheless, even getting back to a P/E ratio of 16.7 for the S&P 500, when the current PE ratio is 25.6, would signify either miraculously skyrocketing earnings or a sharp contraction of the market. The first option is a near impossibility. And the second option?

Markets overshoot, which is what reversion to the mean entails: the average isn’t going to be the floor! And that’s why this type of unsustainably high earnings-multiple is like a tsunami siren where the arrival time of the tsunami remains unknown – and that’s why it is ignored until it’s too late.

Already, bankruptcies are surging as the “credit cycle” exacts its pound of flesh. Read… Consumers and Businesses Buckle under their Debts


GUS100CORRINA rccalhoun Wed, 07/12/2017 - 15:25 Permalink

Any discussion without the inclusion of DEBT does not present the whole picture.If DEBT was included in discussion and figure calculations, we would see that MANY SIRENS of ALL KINDS are going off everywhere!Debt-leveraged buy backs have suppressed P/E expansion significantly. We are way beyond a P/E of 26! Corporate balance sheet debt is up 100% since z"OBOZO" took office.NEED I SAY MORE!!!

In reply to by rccalhoun

Ink Pusher DC Beastie Boy Wed, 07/12/2017 - 15:15 Permalink

*Or , it's a bunch of marks being sold the sublime /sub-prime fantasy and the connected gangs of greedy myopic fools just can't seem to get enough.....It used to be a "sucker born every minute" but with the invention of algos and quantum rigs the suckers P.T. was referring to; are now reproducing uncontrollably and exponentially by the nanosecond.

In reply to by DC Beastie Boy

onthedeschutes Wed, 07/12/2017 - 15:31 Permalink

PE ratio??  Seriously...PE ratio analysis went out the window when the global central banks started buying stocks.  Your PE ratios mean nothing anymore.  Same for charts, technical analysis, fundamental analysis...they are all useless now.  So long as central banks are buying...the market will remain as it is...on an unabating upward trajectory...until the war starts. 

Righttoarmbears Wed, 07/12/2017 - 15:54 Permalink

the real rate of inflation is way above the Government generated figure of 2% more like 7-8%  if you factor in all the bits that most government statistics conveniently leave out like rent and other things the normal people have to buy!! and P&E of 15.5 is pretty generous for a stagnant company, but then its all become  bit fantasy land of recent so do facts matter at all?

Fartboxbuffet (not verified) Wed, 07/12/2017 - 15:50 Permalink

Wheres the wave i want the fukin wave wipe it all out sick of this bullshit year after year

Rebelrebel7 (not verified) Wed, 07/12/2017 - 15:52 Permalink

When I consider the Federal Reserve and people's backs, only knives come to mind.

idontcare Herdee Wed, 07/12/2017 - 18:53 Permalink

33,000 then T I M B E R .... unless the top is at 21, 666.... BTW, you do realize  (in numerology) that today's closing # of 21,532 is 13 which is "the number of upheaval so that new ground can be broken".  Whether that "upheaval" is revitalizing or destructive depends on the Karma of the system/individual represented by the #13.

In reply to by Herdee