Tuesday, February 3, 2009

S&P - Kitchen Sinks & Miracles

S&P finally got around to updating their spreadsheet that shows their forecasts for EPS. Disturbingly, (at least for me), the forecast column for operating EPS had for about two weeks been replaced with the statement, "This series is under review should be posted soon." Not exactly reassuring in the current environment, particularly when it appeared beneath these bullet points:
  • Operating set for the 6th quarter of negative growth, a new record (5 in Q4,'00-Q4, and Q4, 90-Q4,'91)
  • As Reported also set for 6th, but did so during Q1,'51-Q2,'52
  • Q4 Financial decline is worse than it appears: Q4,'08 is estimated at $-4.89 and Q4,'07 was $-4.05
  • Operating EPS coming in 8% lower than top-down estimate, Staples coming in slightly better than expected, continued large Financial loss

S&P also makes this statement: Expect charges to continue for Q4, as companies clean house for a better 2009. When this line is combined with the numbers in the chart, it can be inferred that S&P is expecting this to be the Kitchen Sink quarter. Just because I'm a somewhat petty person, the charts of operating and as reported EPS that follow include S&P's prior forecasts. Obviously, 6/30 (Q2) and 9/30 (Q3) are concrete at this point and Q4 is 65% reported.

Readers of this blog probably have looked through the historic data and would probably discover that as reported EPS has never been negative. The write-downs expected for this quarter are that severe. Looking at the recovery in Q1/2009, S&P clearly believes that the Q4/2008 is going to be the nadir of EPS.

Considering the track record and the less-than-transparent process of marking assets, it remains to be seen whether this will be true. The operating EPS estimates for Q4/08 went from $24.62 on 9/3/08 to $8.19 on 2/3/09. If the as reported and operating EPS forecasts are compared looking out past this quarter however, there is clearly expectation for some write-downs to continue since the difference between these two values averages well over $5 through 2009. It appears that S&P thinks that these charges will be mostly confined to the financial sector. (I'll probably tackle this a bit more in a follow-up post in the next couple of days.)

Also interesting is the miraculous recovery that S&P anticipates in their opEPS forecast. Considering that operating earnings are supposed to ignore charge-offs and other incidentals, the leap from $8.19 to $14.64 would be an unprecedented percentage gain in opEPS for a single quarter. (As reported EPS has managed larger percentage gains, presumably because of the calculation.) However, the S&P Q4/09 estimate has EPS running below my guesstimate of growth from an earlier post on the topic. In that post, I estimated an EPS growth rate of 4% and extrapolated from Q3 information. Clearly the estimate for Q4/08 was horrendously inaccurate but the difference between this guess based on history and current S&P estimates for Q4/09 is $1 or a bit over 5% off. See the chart on the left, which also helps provide some context.

So how does this affect the valuation assessment of SPX? What version of EPS do you want to utilize? Bulls will seize on the PE based on opEPS which at today's close on a ttm basis is 14.68, assuming that the EPS value from S&P turns out to be accurate. However, on an as reported EPS basis, the PE is 28.74. This latter value is actually what S&P will report for PE on its own website. For historical reference, I would refer back to my earlier post on PE values. For the lazy, historic average as reported PE has been a bit over 16.5. So it's still not "cheap", unless you're a blinkered bull that wants to muddle the discussion by ignoring the differing EPS values used to assess PE. If you are one of those... I doubt you would be reading this, honestly. On a forward PE basis, things are equally divergent with the opEPS estimates coming up with 12.17 and arEPS calculating to 20.02. I've stated in an earlier post that Cliff Asness has estimated forward PE values based on operating earnings to historically have averaged around 11. Again, not cheap. When the historical average for PE(ttm,arEPS) is matched with anticipated arEPS for 2009, a level of 691 is calculated for the end of 2009. If you are feeling more bullish (or less morbid), the average PE (ttm) based on opEPS from 1988 to the present has been about 19 (charitably including the dot-com bubble period) and thus produces a SPX level of 1330.76 for the year's end. I'll pause here for laughter.

Bottom line, any significant rally of SPX from here will further shift valuation out of line with forecast and historical norms. (Excepting the "norms" of the aforementioned insane bulls.) That being said, in my opinion, this market has become more or less untethered to objective reality and now is like a balloon subjected to the gusts of panic and euphoria brought on by reactions to the latest macro data point, Bad Bank, or pundit dribble.


Anonymous said...

first thanks for the interesting article.

I write this on Friday 13 Feb 2009 at13:52 EST.

www.reuters.com shows oil at 10.39%

bloomberg has nymex crude furture oil at +11.48, with wti cushing spot at 4.94%

However dated brent spot is -1.52

google shows djaigcl at -1.87%
Proshares ulrashort crude (sco) at 5.71%
Proshares ultra crude (uco)at 5.80%

So proshares are tracking around 3X. However djaigcl certainly does not seem to track wto spot, certainly not nymex crude, and seems closer to brent dated.

all very strange. this looks like a casino

However, djaigcl bears no relation at all to nymex crude future or wti cushing spot

Mr. Sparkle said...

Anonymous - thanks for your comment. I think it was meant to go up on the post about UCO/SCO though.

To address your concerns...
First, I think that you happened to see an odd delay in the data reporting. When I looked at the page you referenced on Bloomberg, WTI front and spot were both 37.51/bbl, up 10.39%. DJAIGCL was up 6.41% on Friday. Keep in mind that Friday saw the front contract rise considerably while the 2nd month actually dropped a small amount as the spread tightened.

Your observations of SCO/UCO tend to follow from the post, noting that these ultra funds suffer from tracking errors on a fairly consistent basis.

I do believe you are incorrect in asserting that DJAIGCL bears no relation to NYMEX crude or WTI cushing. Run the numbers yourself using the links. You can find historic data for DJAIGCL at Yahoo and the closing spot price for WTI from EIA. I think you'll find the results confirm what I have posted.