Jewish World Review Oct. 29, 2002 / 28 Mar-Cheshvan, 5763
http://www.jewishworldreview.com | Earnings season is nearly behind us, and by most accounts there is reason for guarded optimism about corporate performance and about the markets. Note the word "guarded."
With 359 companies in the Standard and Poor's 500 reporting, 59 percent have beaten Wall Street analyst earnings estimates, according to First Call. But, as First Call's Chuck Hill is fast to point out, actual earnings always beat estimates. A more telling measure is by how much the actual results beat forecasts.
Over the last eight years, total actual earnings for the S&P 500 companies have outpaced final estimated earnings by an average of 2.8 percent. Right now, more than midway through the reporting season, that number stands at 3.4 percent.
However, that figure has been distorted upward by Microsoft's stronger-than-expected results. Hill cautions that we still haven't heard from the big oil and energy companies, which could pull the numbers back down to the historical average - a performance that would be far from spectacular, but better than the previous quarter.
Subodh Kumar, chief investment strategist for CIBC World Markets, believes earnings set a bottom late last year. But he adds, "The earnings situation through most of this year has been improving mainly because of cost-cutting. What the market would like to see is earnings improving also because of revenue gains."
Kumar says that will happen, but most likely not until next year, assuming the economy meets forecasts and grows at a rate of 2.5 percent to 3 percent and the recovery in Europe picks up.
There's also reason for guarded optimism about the quality of corporate earnings. This week, Standard and Poor's released its new calculations of what it calls "core earnings," which adjust for the expensing of stock options and the actual rate of return of a company's pension funds (as opposed to the expected return).
The market dive has brought the issue of pension fund accounting firmly to the forefront. A recent report by Credit Suisse First Boston finds that by the end of this year, S&P companies with defined benefit pensions plans could be underfunded by as much as $243 billion dollars - the first time this has happened since 1993.
Not surprisingly, by the S&P's new tougher measure, corporate earnings were significantly lower for the 12-month period ending in June compared with the existing standard. So why is this good news? Because S&P's new numbers bring earnings reporting closer to reality, which is key to restoring investor confidence in Corporate America.
Professor Jeremy Siegel of Wharton calls S&P's new earnings measure "a very important step forward," although he disagrees with the way they determine pension costs. I also applaud S&P, and hope the Financial Accounting Standards Board (FASB) follows suit. It should also introduce its own tougher earnings standard and require options expensing. Both moves would also help restore investors' faith.
Another step forward for earnings quality: The Securities and Exchange Commission on Friday finally appointed former William Webster as head of the new accounting oversight board, created to police the accounting industry. Webster, a former FBI and CIA chief, does not have the accounting experience of the other candidate who was vying for the post, pension fund chief John Biggs. Still, Webster is considered highly competent.
Slow but steady earnings improvement and better earnings quality are also two reasons to feel guardedly optimistic about the stock market.
"There's good evidence that the bottom has been reached," Siegel says.
Says Kumar: "If we get a reasonably good earnings cycle, than 12 to 18 months down the road we could see the S&P 500 back around 1,200."
Of course, there are other looming factors, such as the potential war against Iraq. Bryan Piskorowski, a market analyst at Prudential Financial, says he's encouraged by the action of late, but he warns that if war comes, we'll have "to contend with those consequences." He adds, however, that "history has shown the market has a much harder time dealing with the uncertainty of war than actually with the war itself."
Perhaps one more reason for cautious optimism.
Enjoy this writer's work? Why not sign-up for the daily JWR update. It's free. Just click here.
10/22/02: Economy's strength tied to national security