New York, NY – According to an article published in this morning’s Wall Street Journal, sell-side analysts continue to reveal a bullish bias that may not be consistent with the mounting evidence seen in the U.S. economy.
Thompson Reuters reports that the current consensus earnings estimate for the 2011 S&P 500 would equal $96.25 per share – representing 17% growth above the 2010 figure. However, this surge in Wall Street estimates of earnings is inconsistent with economists’ views of the strength in the real economy.
In fact, last week the U.S. Federal Reserve dropped its 2010 GDP prediction to 3 to 3.5 percent, down from a 3.2 to 3.7 percent forecast made in April. Most Wall Street economists have been more bearish, lowering their second-quarter GDP estimates down towards 2% on disappointing retail sales and trade data.
The WSJ article suggests that some Wall Street analysts think the stock market will outperform the US economy because US companies are generating an increasing percentage of their sales and earnings from faster growing Asian economies. While this might be true, it is unlikely that Asia is driving US companies’ earnings significantly. S&P analyst Howard Silverblatt suggests that Asia ex-Japan contributed only 13% of the sales of S&P 500 companies last year.
A more likely reason is that the optimism seen in 2011 earnings estimates are merely a reflection of Wall Street analysts’ general bullish bias. This is consistent with a McKinsey report we wrote about a few months ago.
In this report, McKinsey reported that over the past 25 years, Wall Street analysts’ earnings estimates have been on average 100% too high. This reflects earnings estimate growth ranging from 10% to 12% per year, compared to actual earnings growth of 6%. The McKinsey study found that over the 25 year period, Wall Street analysts’ forecasts have been lower than actual in only two periods during the earnings recovery following recessions.
We suspect that Wall Street analyst estimates are too optimistic for a number of reasons. Certainly, some continue to argue that Wall Street remains overly optimistic about many companies’ prospects due to the investment banking fees they receive.
However, we suspect that a less nefarious reason is too blame. We suspect that in a post Reg FD world, many Wall Street analysts are relying more on management guidance than on original forensic or primary research than they did in the past. Consequently, Wall Street analysts are basing their optimistic earnings estimates on company management who are providing overly optimistic guidance.
Interestingly, US investors are currently paying more attention to the weak economic data that has recently been reported rather than on Wall Street analysts’ earnings estimates. This is evident in the fact that the S&P 500 is currently trading at 12 times forecasted earnings for the coming 4 quarters – well below the historical earnings multiple of 14.7 for the same period.