Earnings growth may already be discounted

It's earnings reporting season again, so let's look at what is in store.

Standard & Poor's has projected full-year per-share earnings in excess of $60 for the S&P 500 under generally accepted accounting principles (GAAP) and operating earnings above $70. Operating earnings per share are seen rising 10 percent for the S&P 500, 15 percent for the S&P MidCap 400, and 20 percent for the S&P SmallCap 600. The second half is projected to show a slight improvement over the first.

In reporting these, Sam Stovall, chief investment strategist for Standard & Poor's, points out: "[E]quity valuations are not out of line. In fact, the S&P 500's GAAP p-e of 20.7 is a shade below its average of 21.5, dating back to 1984. But we note that the S&P 500 would have to decline 25% in order for its current p-e to equal the average p-e of 15.5 since 1935."

Meanwhile, Mark Hulbert reminds investors in a CBS MarketWatch commentary that fast-paced earnings growth is not necessarily bullish for the stock market as a whole.

In a commentary entitled "A cautionary tale about earnings", he points out:

Over the last eighty years, the S&P 500 has turned in some of its most mediocre showings during periods in which quarterly earnings were growing the fastest. In fact, but for the very worst quarters - ones in which earnings fell by more than 25% -- there was a perfectly inverse relationship: On average, the faster the earnings growth, the lower the S&P 500 return.

... [A]ccording to Martin Zweig, the fund manager and former newsletter editor who Ned Davis Research credits with noticing the phenomenon, is realizing that the stock market is a discounting mechanism, anticipating the future rather than merely keeping score on what's already happened.

This leads Hulbert to the following conclusion:

The stock market's current level may be close to discounting the earnings growth that will take place during the "up" phase of the current economic cycle - even if that growth lasts for another several quarters. If so, then the market fairly soon - if it has not already - will begin to acquire an increasingly negative tone as it progressively discounts what is likely to happen during the next "down" phase of the economy.

In addition, investors also may have to deal with the impact of stock options expensing, which is due to take effect in June this year. I discuss stock options expensing in the US and Singapore in "Companies react as stock options expensing takes effect".