The Consensus Earnings Estimate

There is a memorable scene near the end of The Wizard of Oz where the Wicked Witch of the West gets a pail of water thrown on her and can be heard wallowing, "I'm melting, melting, melting."    Her exclamation is apropos for the 2009 consensus earnings estimate for it, too, is melting, melting, melting.

Unlike the Wicked Witch, we should all hope that the earnings estimate doesn't melt away completely.  If it did, we'd be in a heap of economic trouble.

Since the week ending Sept. 5, 2008, the calendar 2009 consensus earnings estimate for the S&P 500 has been slashed 28%.  Despite the sharp revision, there is plenty of reason still to think that the path of least resistance for the consensus number remains to the downside. 

Source: Thomson Reuters

A continuation of dour economic news, a rising level of job cut announcements, the stronger dollar, capex cutbacks, and indisputable evidence of a retrenchment in consumer spending have been among the driving factors for the curtailment in calendar 2009 earnings expectations.

During 2008 the financial sector was the major drag on earnings estimates for obvious reasons.  The consumer discretionary sector was also a leading cohort in keeping earnings growth from all that it could be.  Despite the weighty influence of these two areas, earnings growth through the first three quarters in the remaining sectors, particularly energy, acted as an important offset.

Still, the market took little comfort in the non-financial story.  Instead it was busy discounting cuts to consensus estimates for the other sectors that it knew were inevitable given the growing wave of bad economic news. 

The market has a knack for following the trend in consensus estimates, only this time it got out well ahead of analysts. 

In the period from Sept. 5 to its Nov. 21 low, the S&P 500 plummeted 40%.  In that same period, the consensus earnings estimate for 2009 was cut only 19%.

The market, of course, has rebounded sharply since the aforementioned low (up 26% as of this posting).  The calendar 2009 consensus earnings estimate, meanwhile, has not.  It has since been reduced to $76.78. 

The divergence would suggest that further consensus estimate cuts have already been accounted for by the market.  A consensus estimate of $63.65, incidentally, would mark a 40% decline from where the consensus number for calendar 2009 stood on Sept. 5, 2008.

It's not a stretch to think analysts will still get there, but rest assured it will be the market that sets the course as to whether analysts go even further still.  For whatever reason, if the market thinks a 40% cut in the consensus estimate since Sept. 5 still isn't enough, then its concern will be clear to see in stock prices.

For now, the market seems to be comfortable with the thought that it has already extracted its pound of consensus estimate flesh and needs no more. 

Now, if only it could find those ruby red slippers, it could click its heels and recall 2008 simply as a really bad dream.

--Patrick J. O'Hare, Briefing.com