How do you know stocks are a little overextended? A good indicator is when even the most bullish sellside analyst on Wall Street, Morgan Stanley’s Michael Wilson, whose year-end price target of 2,700 is the highest of all his peers, warns that stocks may see “pullback or consolidation” and that the coming earnings season may be a “sell the news event.”
Looking at the recent surge in the S&P, Wilson writes that broad stock index had gotten ahead of itself, reaching the low end of the bank’s short term target (2550-75) for the index prior to earnings beginning (it hit 2,552 earlier this morning). He attributed this rush to buy stocks on the “too low” consensus forecast for Q3 EPS:
The consensus bottom-up forecast for 3Q S&P 500 is just 2.6% and appears too low. A strong 1H and a reluctance of corporates to raise guidance meant that mechanically 2H numbers needed to drift lower. With continued strength in economic growth and momentum in our proprietary leading earnings indicator we think companies will once again deliver versus consensus expectations. Look for continued contribution to overall earnings growth from Tech, Energy, and Financials (ex-Insurance). Accounting changes may also bring forward some earnings recognition, further supporting earnings growth. While the market will be focused on earnings over the next few weeks, bigger picture, NTM EPS estimates continue to rise, which should be a bigger driver of the market’s direction. Looking past calendar year 2017, Wilson underscores the departure observed previously in that twelve month forward earnings have continued their upward trend, instead of being dragged sharply lower, “so the upward trend in NTM EPS is an important factor to consider when thinking about the primary direction of the market.” Indeed, 2017 and 2018 so far appear different from the past three years, which saw zero EPS growth and the only upside in the S&P was due to multiple expansion, i.e., central bank liquidity. This time may be different… unless of course there is a sharp economic decline, which would lead to – you guessed it – an earnings drop.
This post was published at Zero Hedge on Oct 9, 2017.