A Scary Earnings Chart Gets Scarier

US company earnings continue to falter, and the gap between actual and expected earnings continues to grow.

If you’ve been reading my articles in Money Morning and Port Phillip Insider, then no doubt you’re sick of me showing you the chart below. But I believe it’s the most important chart any investor should see.

It’s not a technical analyst’s chart. It doesn’t have trend lines, MACDs, RSIs, or Moving Averages. It just has a white line and a green line.

That’s it.

But it’s important because it shows you just how much the world’s markets are ignoring reality.

If you’ve seen this chart before, you’ll know what it’s all about:

 

[Click to enlarge]

Everything to the left of the green vertical line is actual historical earnings for the US S&P 500 index.

Everything to the right of the green line is estimated earnings for the same index.

You don’t need to be WD Gann to see that there’s a problem with the chart. You can see that, since early 2015, company earnings per share have been in decline.

Yet, despite the decline, Wall Street continues to believe that there’s a ‘pot of gold’ at the end of the rainbow…or light at the end of the tunnel.

The worse earnings get, the more optimistic the market becomes. That’s why the US stock market is now trading around a record high.

Based on current estimates, Wall Street believes that US companies will increase earnings by 16%. See for yourself. When was the last time that happened?

The last time was in 2010–2011, when the market and US economy were recovering from the worst slump since the Great Depression.

That means, in 2010 and 2011, US stocks weren’t trading at a record high. They were far from it. In which case, earnings growth was realistic.

Today, that isn’t so much the case.

If you look further to the left of the chart, you’ll notice what happened the last time the market hit a peak, and earnings began to fall. That’s right, earnings really began to fall — leading to the 2008 crash.

The difference today is that for all the good central bank intervention hasn’t done for the world’s economies, investors continue to believe that if things get a bit hairy, the central banks will print money again.

And if they print money, that means more optimism and higher stock prices.

That’s the theory. The reality may be different.

It’s hard to think about money printing and the effect on stock markets without thinking about Japan. The chart below is the Nikkei 225 index going back to 1970:

 

[Click to enlarge]

Japan’s market peaked in 1989. And any investor who has bought stocks since on the prospect of getting rich from money printing, has been sorely disappointed.

Since 1970, the Nikkei 225 is up 565%. That’s a not-so-sweet annualised return of 4.2%.

However, since the end of the first slump for Japanese stocks in 1992, through to today, the total return for stocks (not including dividends) is just 5.3%. That’s an annualised average gain of just 0.21%.

Considering that Japan has supposedly flirted with deflation for much of that time, you could argue that’s a pretty good return — especially if you add in dividends.

You could argue that. But we’re neither convinced that it’s an acceptable return, nor that the policy of money printing is successful over the long term.

So, when we see stocks trading at a record high…and earnings estimates stuck at an unrealistic level…and compare that to the stock market history of Japan, we continue to wonder whether investors as a whole really have lost the plot.

In short, we think they have.

How much longer can this last?

Speaking of sky-high and ridiculous valuations, we continue to be amazed at the share price progress of US car company, Tesla Motors Inc [NASDAQ:TSLA].

The shares currently trade at US$228.36. They have gained 701% over the past five years.

That, dear friend, is an impressive result.

However, aside from the early growth spurt, the share price’s continued elevation comes at a time when the company is struggling to prove it can meet its own lofty sales projections.

As you may recall, earlier this year, Tesla announced it was taking deposits of US$1,000 from those who wanted to get their name down on its brand new model, due to be released in late…2017.

The deposit was and is, fully refundable.

And while the enthusiasm to pay the deposit was huge, it ignored the fact that if no-one asked for a refund of their deposit, it would take something like five years for Tesla to produce all the cars necessary to meet the demand.

However, the image-conscious company may be trying it’s luck with its constant PR.

In the latest announcement from Tesla, company founder, Elon Musk, has issued an update to the company’s 10-year plan. As the Financial Times reports:

Writing on his company’s blog, Mr Musk on Wednesday laid out what he described as an update to the Tesla “master plan” he first published 10 years ago. It will involve Tesla expanding to make a full range of electric cars, buses and trucks, as well as a smartphone app through which Tesla owners will one day earn money by renting out their self-driving cars.

Huh?

On the final point about an ‘app’ and ‘self-driving cars’, we can only think that it’s somewhat of a conditional bet.

In order for Tesla owners to make money by renting out their self-driving cars, you have to believe that self-driving cars will become a mainstream reality.

As I discussed with Port Phillip Publishing’s Managing Editor, Bernd Struben, over coffee today, we just don’t see the point of self-driving cars. If you’re in the car and you’re not driving it, what are you doing?

If you’re doing something, you may as well be driving. Driving, is after all, much more interesting than being a passenger.

Self-driving trucks, delivery vehicles, trains, trams, and buses. We get that concept. It could work. But self-driving cars? No. We don’t buy it.

And looking at the near-record-high Tesla share price, we wouldn’t buy Tesla shares eithers. If ever there was a stock to consider short-selling, this one must surely be near the top.

A big short

As a point of interest, short-selling Tesla’s stock isn’t a novel idea. According to Bloomberg, 27.7% of the company’s stock has been short-sold by bearish investors!

Looking at the chart of the Tesla share price, we wonder how many of them are in profit:

 

[Click to enlarge]

Our guess is, very few.

We can only think that each time Mr Musk opens his mouth and the share price soars higher, the short-sellers must be cursing the inability of those who own the other 72.3% of the company’s stock to see what is plainly clear — to them at least — that the company isn’t worth what it’s currently worth.

Cheers,

Kris Sayce,/>
Publisher, Money Morning

Editor’s note: The above article was is an edited extract from Port Phillip Insider.

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Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

Money Morning Australia is published by Port Phillip Publishing, an independent financial publisher based in Melbourne, Australia. As an Australian financial services license holder we are subject to the regulations and laws of Corporations Act and Financial Services Act.


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