s&p 500-good read

  1. 1,218 Posts.
    Finally the issue of earnings quality isn’t addressed adequately in company press conferences or by media coverage. In the words of UBS analyst David Bianco, “In our view, the quality of earnings for the S&P 500 from an accounting standpoint is the worst it has been in more than a decade.”

    Companies still routinely exclude stock option expense which overinflates income. In addition to stock option expense they also overstate earnings by overinflating returns on pension investments. Many company pension plans have been losing money while their pension assumptions remain positive.

    The gulf between pro forma earnings (C.R.A.P. - cloudy reporting accounting principles) and real earnings (GAAP - generally accepted accounting principles) keeps getting larger. Last year GAAP earnings for the S&P 500 were $28. The pro forma numbers used by Wall Street and the financial media was $47.26. We are seeing growth rates in pro forma earnings that veer far away from actual earnings numbers according to GAAP. There is also a widening canyon between the operating numbers used by analysts and anchors and those reported to the government and used in the national income accounts.

    We are still dealing with bogus numbers, a fact that is starting to get the attention of foreign investors that the U.S. markets are no longer clean. Last week the Financial Times ran an article on the rigging of the U.S. markets. It may be one reason that many foreign entities are pulling out of the U.S. We once were considered to be the model that other markets strived for; now we have become the one they try to avoid. Over the weekend the ECB recommended that all of its member central banks dump all of their holdings of Freddie Mac and Fannie Mae due to accounting irregularities. Freddie Mac is currently under investigation by the SEC and federal prosecutors after understating earnings by $4.5 billion leading to the resignation of the firm’s top three execs. Foreign institutions and governments are now starting to pay more attention to accounting issues and earnings quality. The constant accounting scandals are starting to get everyone’s attention overseas, even though they are ignored by investors domestically.

    There is a lot riding in this market on a second half recovery. There are big expectations for earnings in Q2 & Q4, especially in the tech sector. There is nothing reported, at least so far that would support these expectations. This means at some point, either in September if not before, when companies start confessing Q3 results a serious realignment of expectations is going to take place. Unless the dollar plunges rapidly enough to impact earnings through currency gains it is hard to see where the next earnings catalyst will come from. Wall Street’s credibility is now at stake. The Street has been predicting a second half recovery for four years now. Now it is time to pony up and deliver or face a severe retraction. The recent rally has gotten way ahead of even the most optimistic expectations with stocks now sporting bubble valuation in almost all indexes. As of the close today the Dow is selling at 30X trailing earnings, the S&P 500 trades at 29X 12 month profits, and the Nasdaq 100 is selling at 233 times trailing profits. That is a market that is priced for years of perfection when none actually exists.

    The Silver Streak

    There is another bull in town that is starting to get investors attention which is the precious metals and energy markets. Gold is in a new bull market and has been recently joined by silver. Silver has risen more than 10 percent in seven trading days last week and was up another $.12 today to close at $5.195. That price increase has moved up with increased volume to hit $5.20 intraday. This has gotten the attention of many precious metals bulls. Up until now silver has failed to confirm the new bull market in gold. Just as in Dow Theory the Transports and Industrials must confirm each other, it is the same in the precious metals markets where silver is an important confirmation of gold.

    Many silver bulls, I include myself as one of them, believe that the upside potential in silver is enormous. James Turk, editor of the Freemarket Gold & Money Report, thinks that silver could hit $6.45 by September. I personally believe that silver could actually go much higher. The reason is that there isn’t much of it around and what there is has been shorted heavily. Large monster short positions on the COMEX have kept silver suppressed now for more than a decade. As I wrote in my last Storm Update, “Silver, an Undervalued Asset Looking for a Catalyst”, shorting silver has been a one-way trade. The shorts have controlled the silver market for far too long. They have shorted the bullion and they have shorted the stocks. As shown below, short positions in the silver stocks went up last month and are up substantially over the last year.

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