In the rough seas of financial forecasting, the mainstream "captains" have always relied on certain time-honored tools for navigation: Breaking news, GDP figures, political scandals, weather patterns, and so on.
But of all the measurements, there is one gauge widely considered to be the "North Star" of financial prognostication -- that ever-fixed mark in the economic sky that always points to the "true" future performance of major stock averages. And that gauge is earnings.
Here, the following news items from May 16 set the scene:
- "Stocks Start Week With Losses After Earnings Miss."(San Francisco Gate)
- "Stocks Finish Lower On Weak Earnings." (Associated Press)
- "Stocks edge lower as investors found little reason to diverge from a seasonal lull that often drives first-quarter earnings. The 'Sell in May and Go Away' adage has some fundamentals behind it, given that markets tend to move higher on earnings." (MarketWatch)
Well, before you set your to financial compass to the earnings "pole," EWI president Robert Prechter uses the pages of the April Elliott Wave Theorist to exposing a major flaw in the notion that earnings are an objective norm of stock valuation.
In the April 2011 Theorist, Prechter presents the following 80-year chart of the Price of $1 Worth of Annual Earnings from the S&P 500 and writes:
"The stock market never attaches to any benchmark of value. It is ceaselessly dynamic... In the past century, the major stock market averages have fluctuated 23-times around earnings... By the way, the only reason the P/E ratio is listed as fluctuating 'only' 23-times is that the graph used smoothes over data over four quarters. In fourth-quarter 2008, earnings were negative, so the P/E ratio was infinite. I submit that any measure that can fluctuate between six and infinity is not a benchmark at all."
But that's not all. In the same Theorist report, Prechter also reveals how earnings figures themselves are NOT a reflection of current economic growth. Here, Bob presents the chart below of actual earnings VERSUS economic forecasts over the 22-year period of 1986 to 2008.
In Prechter's words:
"Forecasts for earnings lag actual earnings by a year, as do [economists'] forecasts for GDP, interest rates, employment and the stock market."