The Three Things Wall Street Has Wrong

Three Things Wall Street Has Wrong

Bad news used to be good news; an increase in unemployment meant rate cuts were coming, but now bad news is just bad news. And the market is reacting, dipping down over 1% intraday!  Why is everything upside down now and where are S&P 500 earnings telling us the market is headed? We’re going to take a look at that and more…

Let’s start with the first mistake made by Wall Street – they were counting on 7 interest rate cuts from the Fed and now we’re lucky if we will get three this year.  Analysts have been busy developing new targets for the market, based on a significant reduction in interest rate cuts.

Rather than having a scheduled plan, we’re now waiting for jobs and inflation data to give us direction. That leaves plenty of uncertainty and the market hates uncertainty.  Not to mention the Fed indicators are showing a slowdown in slowing momentum. We’re close to the magical 2% inflation, but not there yet. 

Next, Wall Street set annual earnings growth to 10%, instead of 7%. This was largely due to the anticipation of rate cuts.  Wall Street has been trying to figure out the balance of forward price-to-earnings and the expectation of growth.  But several companies, like ULTA, META, and JPM have come out with a lower guidance, warning investors about forward earnings.

Now let’s look at some math.

For CY 2024, analysts are calling for (year-over-year) earnings growth of 10.7%. 

The forward 12-month P/E ratio is 19.9, which is above the 5-year average (19.1) and above the 10-year average (17.8). However, it is below the forward P/E ratio of 21.0 recorded at the end of the first quarter (March 31).

That means if earnings growth in the S&P 500 last year were $225, a 10% increase would be $250.  If we’re trading at a 19.1 multiple, that means a fair value of the SPX at 4900.  

Any change to growth rates will change the multiple and change the fair value of the index.  

Earnings are in line with estimates, but a 20 multiple is not likely to be sustainable.

The last thing that is going wrong is the AI enthusiasm with no evidence of revenue growth compared to stock market price growth.  Similar to the early 2000 tech bubble when companies mentioned they work on the internet and their price went through the roof.

Companies like Super Micro Computer jumped over 300% in three months, yet revenues and earnings growth lag behind their stock price growth.  Now we’re seeing stocks come down to realistic numbers.  It’s not that SMCI shouldn’t trade higher, but the AI bubble is showing signs of a small bubble bursting, at at the very least, resetting.

I’ll keep writing about this topic, but to wrap up today, I’ll leave you with this. The Fed doesn’t take short-term energy prices into consideration for their inflation indicators, so where else can we decrease inflation?  It’s likely wage inflation and profits from companies.  

We’re seeing the Producer Price Index lowering, but the Consumer Price Index is not following suit.  Companies are keeping prices higher to either account for the cost of wages or greed/profteering.  Why drop prices if the resilient consumer is still willing to pay?  Why drop prices and give up profit?

How can the Fed recover and how can we get out of this without a recession? Stay tuned until next week.  We will look at the job market, wage inflation, and so much more!

Have a great weekend!

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