OK, I Get it, this Stock Market Is Going to Be a Mess

With actual P/E Ratios Blowing Out Like this.

Just how overvalued are stocks, particularly small-caps? According to Wall Street, even the question is wrong. Stocks are never overvalued. They’re always a buy. The future looks bright. And even if it doesn’t look bright, analysts come up with “adjusted” earnings that are so brilliant that they blind even innocent bystanders. That’s how Wall Street justifies high stock prices.

Our miraculously visionary analysts see on average an “adjusted” forward P/E ratio for the next 12 months of 15.8 for the Dow, 16.5 for the S&P 500, 17.8 for the Nasdaq, and – get this – 16.5 for the Russell 2000, the small-cap stock market index that tracks the bottom 2,000 stocks in the Russell 3000. If that were an actual P/E ratio, the Russell 2000 would be a screaming buy. But a look at reality shows just how ludicrous these “adjusted” P/E ratios, particularly for the Russell 2000, have become. And how these folks are trying to pull a bag over our heads.

So first things first. Sales are crummy. Worse than crummy. They suck.

Total US business sales – not just sales by S&P 500 companies but also sales by small caps and all other businesses, even those that are not publicly traded – peaked in July 2014 at $1.365 trillion, according to the Census Bureau. By December 2015, total business sales were down 4.6% from that peak. A bad 18 months for sales! They’re back where they’d first been in January 2013!

Sales by S&P 500 companies dropped 3.8% in 2015, according to FactSet, the worst year since the Financial Crisis.

The strong dollar gets blamed, along with the weather. But the strong dollar is a mixed bag. Many companies whose sales are limited to the US don’t feel the strong dollar, except they’re benefiting from the lower input costs it produces. Worse than the strong dollar and the weather: Companies face a slowdown and a very tough environment in the US and globally.

This chart, based on data from the Census Bureau and the St. Louis Fed, shows just how lousy sales have been since their peak in July 2014:


The last two times total business sales declined like this were linked to recessions: just before and during the 2001 recession, sales dropped 5.0% in 12 months; and during the Financial Crisis, sales fell off the cliff, as seen in the chart.

These terrible sales have whacked earnings! According to generally accepted accounting principles, or GAAP, the most hated term on Wall Street, earnings have swooned in 2015. For example, for the S&P 500, earnings plunged 12.7% according to GAAP, even as Wall Street fed us the idea that they only fell 3.4%, based on its fantasy “adjusted” numbers.

With earnings down sharply, but with share prices down only a little, the resulting P/E ratios, despite the decline in stock prices, have soared, indicating just how expensive stocks are getting.

The trailing 12-month P/E ratio based on GAAP for the S&P 500 jumped to 23 as of March 4. That’s very high. Especially now that revenues and earnings are both heading south. The NASDAQ and the Dow suffer from similar if lesser distortions. For P/E ratios to get back to something resembling sanity, earnings would have to soar (unlikely in this environment) or share prices would have to drop – and by a lot.

But the Russell 2000, oh my! Based on GAAP earnings over the past 12 months, its P/E ratio soared from an already ludicrous 80 a year ago to a magnificently ludicrous 687.8 as of March 4.

The decimal is in the correct location. The problem is that the 2000 companies in the index – so not just a few oil and gas drillers – have seen their earnings totally collapse. But this is the hilarious part: Wall Street has stamped on the Russell 2000 an “adjusted” forward 12-month P/E ratio of 16.5:


How can this be? This is the difference between some sense of reality that comes with GAAP accounting rules though they can be jiggered and jimmied into place as well, and pro-forma, ex-items, adjusted earnings doctored up by analysts whose sole purpose is to pump up stock prices.

Sell-side analysts are not allowed to look back at reality as it happened. They’d get fired. The past can be measured, and their shenanigans become too obvious. So they’re only allowed to look at an “adjusted” image of the past – and only briefly. Instead, they must focus on the future, which they can easily control and mold to perfection in their pronouncements.

These analysts ought to be laughed out of the room, but they aren’t. Their pronouncements are reprinted and cited reverentially in the financial media and fed to the investing public to make them feel good about paying enormous amounts of money for companies with terrible earnings and struggling in an environment of declining sales.

This is another sign that the stock bubble is still highly inflated though it has been deflating in fits and starts since its peak in May 2015, and that based on the harsh reality of P/E ratios under GAAP, it has a lot further to deflate.

The “negative ripple effects” of the oil bust, are however, spreading out. Read…  Dallas Fed Unplugs Oil Bulls, Warns of Liquidity Crunch, Contagion

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  42 comments for “OK, I Get it, this Stock Market Is Going to Be a Mess

  1. Álvaro says:

    Here in Spain is already Monday morning, let’s get this party started.

    ♪ I gotta feeling that tonight’s gonna be a good night
    That tonight’s gonna be a good night
    That tonight’s gonna be a good, good night ♫

    A feeling ♫ that tonight’s gonna be a good night
    That tonight’s gonna be a good night ♫
    That tonight’s gonna be a good, good night ♪ ♪

  2. Thomas Malthus says:

    Doomalishiss! You shan’t find an article like this in the MSM

  3. Mick says:

    I take govt stats with a huge grain of salt. I know lots of people in lots of different industries, even govt contractors, and business is down a whole lot more than 4.8%

    In Brit

    • Mick says:

      Bugged out, here’s the rest.

      In British Columbia and Alberta, provincial govts have quietly halted all hydroelectric infrastructure projects.

      And by halted, I mean halted. Zero, zip, nada. Normally there would be 10-30 projects between the two provinces in any given year.
      I’ve never seen a year with zero, this is a first.
      Very telling about how serious it’s become in Canada.

      And if govts are halting projects, obviously business is way, way down.

      This is so different from 2008. In 2008, it was a panic which caused the downturn. This time it’s far worse but everyone is extremely complacent, even laid off workers.

      It’s like a deep, mass delusion has gripped everyone, like never before in history.

      • Pete says:

        Hi Mick:
        I agree with your assessment:
        “This is so different from 2008. In 2008, it was a panic which caused the downturn. This time it’s far worse but everyone is extremely complacent, even laid off workers.
        It’s like a deep, mass delusion has gripped everyone, like never before in history.”
        Can you please give us a source on the halt of the hydro projects?
        I just drove by on Hwy. 7 and they seem to be still working on one east of Maple Ridge.

      • Shawn says:

        Why worry about the economy, you can still flip your house in Vancouver or Toronto for 3 million dollars.

    • Curious Cat says:

      So much for the efficient market hypothesis. I didn’t see how that could be true even when they tried to teach it to me in 1983!

      “A man hears what he wants to hear and disregards the rest” – Simon and Garfunkel

      • interesting says:

        “So much for the efficient market hypothesis”

        the true meaning of which is the market will efficiently transfer as much money into the pockets of insiders as quickly as possible as the sheep sleep right thru it.

      • bud says:

        you just confirmed that Hillary will be the next president of this USA.

        And, thus so be it. Let her figure how to put Humpty Dumpty back together again, and send me a cool million and I will go about my business.

        Not one person I know can see beyond the next tick of the clock and all believe the Fed has their backs.

  4. NY Geezer says:

    I read recently in Forbes that the US Department of Labor either proposed or issued a fiduciary rule which would require that a “best interest standard” be applied across a rather broad range of investing advice. Under this rule any advisor getting paid to provide personalized investment advice should be considered a fiduciary who is would be required to put their clients’ interests first. Currently, they operate under a “suitability standard,” which means that their recommendations can consider their own and their firms’ interests.

    A broadly applied fiducuary rule for such persons seems to be fair. Yet everyone connected to the investment industry is predicting that it will be the end of the capitalist system that has produced so much good for so many.

    I have no clue how this might be applied to those who report earnings, but wouldn’t it be ironical if they were forced to comply with GAAP.

    • NY Geezer says:

      I just checked the DOL web page. The rule was proposed in 2010, was not adopted, and the next action, if any, will be re-proposal of the rule.

      A potential hole in the government’s capture by the financial industry was closed.

      • Dan Romig says:

        Yesterday on ZeroHedge, Tyler Durden posted an informative piece on this subject.

        ‘Is This The End Of CNBC As We Know It?’

        • BradK says:

          …and I feel fine.

          (with apologies to R.E.M.)

          CNBC is The Onion of the financial media, Kramer the court jester. For entertainment purposes only.

    • Joseph Kane says:

      One of the big issues is that it is applied using hindsight. Know a broker who put a client who was late 60’s into a fixed annuity product in the 1990’s. He was sued by the client’s children for not putting her in the market where she could earn those wonderful returns. He lost. We know what happened a couple of years later… Litigators will be the biggest beneficiaries.

    • walter map says:

      “A broadly applied fiducuary rule for such persons seems to be fair. Yet everyone connected to the investment industry is predicting that it will be the end of the capitalist system that has produced so much good for so many.”

      Right. How can they expect to make any money unless they’re entitled to cheat their customers? Ethics are unprofitable, so pirates naturally prefer legalized racketeering.

  5. Bobster101 says:

    For P/E calculation, Russell 2000 ignores all stocks with P/E over 60.

  6. d says:

    There is a very ugly head and shoulders in that chart. In a bad place.

  7. JP Frogbottom says:

    The fiduciary standard IS a good one, if you are to thrust the personalized wisdom of an adviser with your investments. A good many people lack the knowledge of markets to handle their own allocation, and investment choices. (Yes, they could learn to do it themselves, but many have no interest in it).

    Such a standard should NOT be so broad as to encompass the “opinions” of the pundit classes (Cramer, The Mutual Fund Show, Money talk, etc).
    That is entertainment, no specific financial advice.

    I still think broad based INDEX funds for stocks are best. (I do it myself, so what do I know?). Very Low cost, and you always get what the market returns, minus fund fees. Still, shop around not all INDEX funds are created equal.

  8. Chicken says:

    Sales are much higher than May 2009? Presently in consolidation? I dunno, hard to believe sales are greater than 2006 but maybe. And, all these numbers likely have been fudged for decades…

    Who knows.

    • Wolf Richter says:

      Don’t forget inflation. These numbers are not adjusted for inflation (CPI). Even if inflation isn’t huge, it adds up over the years.

      BTW: that’s one reason corporations love inflation: it inflates their revenues (they get to raise prices).

      • Curious Cat says:

        And they get to pay off their debts in cheaper dollars!

      • walter map says:

        “they get to raise prices”

        And related machinations. Years ago Stephen Jay Gould extrapolated trends which showed that by the end of 1998 the Hershey bar would disappear entirely and would cost forty-seven cents, back when money was worth more. Expecting this outcome would fail to excite their customers, Hershey’s instead disappeared only half the chocolate and raised the price to well over a buck.


        Evidence of collusion between candy makers and dentists remains circumstantial.

      • bud says:

        just ask ebat how that works. Thank you.

  9. nick kelly says:

    Pardon me for a post that is only related to the topic of a general slowdown.
    I think I had a comment removed from CNBC’s site after I questioned their continued parroting of China’s growth numbers. I said I doubted that CNBC, given its resources, actually believed them. How can growth be 6.5 to 7 when imports and exports are down double digits?

    Oh, of course it’s consumer led internal growth, which happily for the CCP we can’t directly measure. ( Although REAL China expert, Ann Stevenson- Yang, who lives there, estimated it at flat to negative a year ago, before its stock market crash )

    Anyway here is a the purest nugget of the MSM China transition story, copied straight from Bloomberg:

    ‘Cheap labor, vast factories and a building spree without parallel powered China’s economic miracle. Times are changing. Services today make up more than half of the nation’s economy as baristas, barbers and baby sitters become the new growth drivers.’

    And we mock the McJobs numbers from our government! At least no one as far as I know has claimed baby sitting as a hot new growth area.
    Baby sitting….
    I just can’t get over Bloomy saying something like that. Is the writer an internal mole trying to sabotage their site?

    • d says:

      Have you seen the cost of early childhood care in Australia??.

      A lot of women go back to work, as they need to stay in the game to keep career seniority and presence. Many of them actually earn very little after child care costs.

      • nick kelly says:

        No doubt- but income in Aus is about 500 percent that of China. Does the Chinese middle class have the extra needed?
        BTW: baby sitting especially in China won’t mean the same as official ‘early childhood care’
        It’s probably about as regulated as pollution, safety etc., i.e. not.

        The jobs that ‘baristas, barbers and baby sitting’ are supposed to replace are the relatively high paying jobs in steel, cement, aluminum, coal mining, construction etc. etc. that were predominately male.

        It’s like saying that laid off iron ore miners making 100K in Aus are going to become babysitters.
        They well might, as the wife heads off to work, but in the China context to talk about this as a replacement for Chinese down sizing of heavy industry and STILL allow a 6-7 % GDP growth rate is to put it politely, wildly optimistic.

        Re: barbers though, the Chinese have been getting more haircuts.

    • Thomas Malthus says:

      Does anyone actually watch CNBC thinking it is serious financial reporting?

      I don’t watch it because I don’t have a TV and if I did I would only tune in as I might a comedy act….

      This pretty much says it all:

      It never ceases to amaze (and amuse) us how much time big bank “economists” and “strategists” spend on Zero Hedge – even though we have never compensated said banks either directly or with soft dollars – instead of doing research, or spending time with their paying clients.

      Just one week ago, it was CitiFX’s Brent Donnelly who was “critical” why the financial media, supposedly, “highlights bearish stories” (perhaps has has missed the past 8 years of CNBC “reporting”… we don’t know). This is what he said:

      Give the people what they want

      In an email I sent Monday, I was critical of the financial media for highlighting bearish stories but ignoring bullish ones. I was thinking about this and realized that maybe you can’t blame the commentators… People just gravitate towards bad news—humans are much more interested in watching a car crash or shooting on TV than a feel-good story.

      I looked at Google searches related to the stock market. The results (Chart1) speak for themselves. My conclusion is that it’s not fair to blame Zerohedge and friends for the permabear newsflow…

      They’re just giving the people what they want!

      To which we had a simple, and logical, response:

      What people want is not bearish news, what they want is the truth, something they, for whatever reason, feel they can’t get from the mainstream media, which in turn has opened up opportunities to alternative media outlets such as “Zerohedge and friends.”

      Incidentally, these outlets are not only not permabears – we remind Mr. Donnelly that our “permabearishly enough “Don’t look down – You might find too many negatives” and which we summarized in the following post: “Citi: we have a problem.”

      More http://www.zerohedge.com/news/2016-03-06/dick-handlers-jefferies-trolls-lightweight-zero-hedge-being-negative-unveils-major-r

  10. Bobster101 says:

    Russell 2000 also ignores companies that are losing money when calculating P/E for index

  11. CENTURION says:

    There is nothing to worry about anymore.

    A few keyboard clicks and the Primary Dealers and buy up all the stocks and bonds and keep the numbers up there.

    “They” must NEVER let the prices fall or it takes out all the State Pensions, Union Pensions and Insurance companies. All.

  12. OutLookingIn says:

    “going to be a mess”?
    This portends something breaking.
    Is it not already way past broken? When GAAP was thrown under the bus?
    When TARP came along, then QE’s 1, 2, & 3, followed by Op Twist?

    No, the markets have been broken for some time now.
    Case in point; Iron ore is up over 300% this morning!
    Really? Come on now, there’s nothing based in reality about this!
    Wall Street continually sings that old Disney tune “When You Wish Upon A Star”… your dreams come true!

    In the prophetic words of George Carlin (may he RIP) “They call it the American Dream because you have to be asleep to believe it”!

    • Dan Romig says:

      Front page in the Minneapolis StarTribune today ‘After “humbling” downturn, Iron Range hopes for a boost’.

      There are 2,111 miners out of work on the Range now, and 7 of the 11 operations idled last year.

      Those working men (and a few women) are wishing upon a star that they can go back to work and take care of their families.

  13. LG says:

    Meh , wait untill the Chinese announce that they will be adding another 1500 miles to the Grat Wall!

  14. Shawn says:

    Can we get a breakdown as to what percentage of the economy is S&P 500 and what percentage is Russel 2000? And given the overvaluation of the S&P, how much of a correction does that amount to.

  15. CAMERON says:

    “The strong dollar gets blamed, along with the weather. But the strong dollar is a mixed bag. Many companies whose sales are limited to the US don’t feel the strong dollar, except they’re benefiting from the lower input costs it produces”.
    Actually, I suggest they are affected by a strong dollar if the businesses are manufacturing locally in the US and there is significant import competition with their products, which there generally is.

    With a strong/appreciating dollar, the imports can suddenly be sold cheaper(and probably will be). The local US manufacturer will inevitably need to cut prices just to maintain market share and there is not any certainty that lower prices will increase total demand significantly. If the business can sustain the same unit sales with price cuts , the total revenue from those units will be lower as the price per unit has been forced lower for the business to remain price competitive in that market. THE business may have some offsetting cost decreases to some degree due to lower import content but only if there is significant import content in their product. But overall the business’ profitability will be worse off if sales revenue declines as described are not offset fully by any cost savings which in many, many cases they just will not be.

    Of course if, despite price cuts, you are also trying to sell into a weakening local market environment with a stagnating or declining total market demand for the product(s), at the same time as import competition enjoying the strong dollar is forcing you to cut prices, it becomes very tough for those businesses.

    • Tim says:

      And so the inevitable tariff increases, to protect local producers. Just recently, calls for >250% tariff increase on some steel imports from China.

      • d says:

        The American rust belt exists, due to chinese dumping.

        Now china is blatantly trying to BANKRUPT every other steel maker on the planet. SO THEIR HUGE STATE SUBSIDIZED INDUSTRY’S with massive overcapacity, can survive.

        china has enough steel capacity to supply the planet, alone.

        Which is their intention. With all their industrial overcapacity.

        The chines position is the same as the Indian one. Make in china/india and let the rest of the world be unemployed, as long as china/india make a profit.

        China and india signed WTO agreements, with no intention of keeping any of them.

        Unless you want your grandchildren to live in the gutter like rats, whilst the chinese and indian’s live like the 1%, which is their intention.

        Big tariffs must be used against those who have no intention of trading fairly.

        Globalization in its current incarnation is a failed experiment, it benefits only those who intend to cheat and exploit.

  16. Agnes says:

    Including tough for the U.S. Post office…apparently their algorithm demands they LOWER prices by two cents for first class postage in April….when they need money to operate and pay benefits due. (Source…visited Post Office today)

  17. chris hauser says:

    IT’S A GROWTH RECESSION, unless you got no growth, aka, in reverse, BUT, YES, CORPORATE PROFITS ARE KINDA HIGH, golly, aren’t they? CAN’T EVERYBODY MAKE A LOT OF MONEY, which means someone has to lose, but they have little voice, so you…..just……don’t……hear…..them.

  18. Now this is interesting. Notice how market orders take items off the queue and change the last price . When people place market orders, the stock price fluctuates. Yes, it’s “just” supply and demand, but it’s pretty cool to know it’s happening real-time in the stock market.

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