Earnings Estimates Are Now Realistic
2020 EPS estimates have fallen so much that they are now realistic. The bad news is based on 2020 estimates, the stock market is expensive. Specifically, the 2020 EPS estimate fell from $178.96 at the start of the year to $132.75. That means the current S&P 500 PE ratio is 21.94. It makes you question any predictions for the stock market to hit a record high soon. The good news is these estimates are probably close to reality and stocks usually look expensive based on trough earnings.
Estimates for 2021 might be too high still. Estimates fell from $195.63 to $165.15. They imply there will be 24.4% growth. On the one hand, usually during recessions earnings projections are too low. That’s the one-time estimates get raised (besides the tax cut).
On the other hand, if analysts see this as a sharp and quick dip lower, estimates might never become too pessimistic. 24% of growth is quite high. Based on that growth rate, the current PE multiple is 17.64. That suggests stocks are fairly valued. If you think low-interest rates and QE help stocks, then maybe there is modest room to rally.
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Also, keep in mind buybacks play a big role in EPS. Buybacks lower the share count or they at least stop it from rising too much because of stock-based compensation. The good news is executive compensation has also been lowered. As you can see from the chart above, in 2020 buybacks will basically be cut in half which hurts EPS.
Also, some companies will be issuing shares which hurts EPS. So far, we’ve seen big debt offerings, but at a certain point, companies will be too leveraged. We might already be at that point for many firms. Boeing just did a $25 billion bond offering.
Buybacks will increase with earnings in 2021, but they won’t get back to the 2018 peak for at least a few years. Firms will want to be conservative after the recession. Finally, dividends are being cut sharply. About $65 billion in dividends have been canceled this year. Shell just cut its dividend for the first time since the 1940s. It was a massive 66% cut.
Lower dividends and expensive multiples make owning stocks not the best bet. It makes sense to pick winners among the rubble because plenty of companies are still very low. Many stocks fell over 50%. Pick the best stocks among those rather than buying stocks that have already recovered.
Very Weak Manufacturing ISM Report
April manufacturing ISM PMI was terrible as it fell from 49.1 to 41.5. Even though that looks bad, it actually masks the worst of the report because the supplier deliveries index spiked 11 points to 76 which was the highest reading since 1979. This index rose because the supply chain is busted. It's not surprising that this index spiked. Economists need to model this strength when coming up with their headline predictions.
If they did, they would have gotten the reading correct. Instead, they wrongly called for a PMI of 37.5. As you can tell, the details of this report were a complete disaster. There have been some indicators that the service sector is taking more pain than the manufacturing sector. You can throw any hopes that the manufacturing sector is doing well out the window if this report is accurate.
New orders index fell 15.1 points to 27.1 which is the 3rd lowest reading ever. Only 2 worse months were June 1980 and November 2008. The production index fell an enormous 20.2 points to 27.5 which is the worst reading on record. Remember, most economic reports don’t go back to the Great Depression.
That means this will be the worst reading ever for many reports. This is the biggest cliff dive the economy ever has seen because recessions don’t cause a complete cessation of economic activity.
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As you can see from the chart above, the employment index fell 16.3 points which was the biggest monthly decline ever. As you can see, this data goes back to the late 1940s. If we had about 18 more years of data, we could compare it to the Great Depression. However, keep in mind, that the Great Depression was terrible because it was a long period of despair. This is the great cessation.
The employment index fell from 43.8 to 27.5 which was the worst reading since June 1949. In keeping with my prediction that the economy is seeing deflation, the prices index fell 2.1 points to 35.3. Let’s see what the prices index in the services PMI shows next week. Within the manufacturing report, the prices that went up were caustic soda, disinfectants & soaps, freight, gloves, masks, and precious metals.
This PMI is consistent with a 0.4% decline in GDP growth. That’s embarrassingly optimistic. Q2 GDP growth is going to be down in the double digits. Markit figure was much more realistic as its PMI fell from 48.5 to 36.1 (down from flash of 36.9); that’s the worst reading since 2009 (the data only goes back to 2008). Among the 6 biggest industries in the manufacturing report, only food, beverage, and tobacco products expanded; that counts as one industry.
Within the comments section of this report, 6 of 10 firms mentioned COVID-19, PPE, or coronavirus. A computer & electronic parts firm stated, “Thirty-percent decrease for April due to COVID-19 impact on both customers and suppliers.” A furniture and related products firm stated, “Dealing with the effects of coronavirus and having 65 percent of our operations down.”
It’s no surprise computer sales didn’t completely crash because many people bought better computers to work from home. There is little reason to buy furniture unless you are buying a desk to work from home at. Online furniture sellers like Wayfair outperformed. I’m very confident this wasn’t a quote from Wayfair because this is in the manufacturing report. These firms manufacture computers and furniture. It’s terrible, but unsurprising sales fell off a cliff in April.
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