Interesting chart to consider

Posted on November 27th, 2012

Sometimes, the simplest blog post can remind you of really important lessons. I found this blog post on Pragmatic Capitalist yesterday. I have copied it below and here is a link to the site.

Basically, this post reminds me again that companies are only worth a discounted value of their future cash flows. So, when future cash flows show signs of weakness and the markets do not show the same weakness, one or the other is wrong. 

The chart shows a more recent divergence between an index that tracks earnings revisions and the world wide markets. You can see the divergence that has occurred since mid-2012. 

Which side of this equation are you on? Do you think the earnings are going to correct and go higher than expected given revisions? Or do you think the market needs to correct backwards? I am in the 2nd camp - but I don't believe the correction is more than 10%. I think it would be a modest correction as earnings also go thru a modest revision period. The next quarter will be critical to answering this question.

One more reason to be hedged at all times!

Chart - courtesy of Bloomberg
TEXT FROM PRAGMATIC CAPITALIST:

With all the macro currents it’s difficult to remember that profits are ultimately the primary driver of stock prices.  This chart via Bloomberg and our friend Martin at Macronomics shows the very close correlation between the changes in earnings expectations and stock prices:

“Lower earnings estimates are dragging down stocks from this year’s highs and their full effect has yet to be felt, according to Hasan S. Tevfik, a global equity strategist at Citigroup Inc. The CHART OF THE DAY compares the performance of an earnings-revision index, or ERI, compiled weekly by Citigroup with MSCI Inc.’s All-Country World Index since the beginning of last year. Tevfik had a similar chart in a report yesterday. Since the first week of May, the revision index has been less than zero, which means there were more estimate cuts than increases among analysts.

The MSCI gauge of stocks in developed and emerging markets rose to its peak for the year in September and then lost as much as 6.7 percent. “ERI remains an anchor for global equity markets,” Tevfik wrote. A similar disparity between estimate changes and share prices in 2011 was resolved when stocks declined in July and August of that year, the London-based strategist added. The chart highlights the earlier retreat. Earnings projections for next year are poised to decline further, he wrote, citing the gap between analysts’ estimates for companies and strategists’ projections for stock indexes.

Citigroup strategists are collectively calling for profit growth of 7 percent, trailing a 12 percent increase implied by company-specific estimates, Tevfik wrote. The lower figure maybe too high, he added, as economic growth slows worldwide.”



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