Path: bloom-picayune.mit.edu!snorkelwacker.mit.edu!news.media.mit.edu!americast.com!americast.com!usa-post Newsgroups: usa-today.bonus From: usa-post@AmeriCast.Com Organization: American Cybercasting Approved: usa-post@AmeriCast.com Subject: bonus Wed, Jul 1 1992 Date: Wed, 1 Jul 92 05:20:57 EDT Message-ID: 07-01 0000 BONUS: Earnings fears hurt outlook USA TODAY Update July 1, 1992 Source: USA TODAY:Gannett National Information Network The honeymoon is ending. Investors in stocks have shown remarkable trust and patience the past 18 months. Stocks have soared as investors poured money into the market on the hope that companies would emerge from the recession in shape to bring home huge earnings gains. HAVE INVESTORS' PATIENCE BEEN WEARING THIN? Last month, the Dow Jones industrial average's performance looked like the flight path of a wounded duck, sliding 3% from its 3413 record close June 1. While that drop has gotten a lot of attention, the rest of the market actually has been falling apart for more than four months. The Standard & Poor's 500 index, also down 3% from its record close, has been slipping since Jan. 15; NASDAQ's composite index of small-company stocks is down 13% from its peak Feb. 12. WHY ARE INVESTORS TURNING AWAY FROM STOCKS? As the second half of the year starts Wednesday, there still are many questions about just how well the economy is doing. And if there's doubt the recovery is sound, there's no reason for investors to believe corporate earnings will live up to optimistic expectations. While it's too early to say the bull market is dead, it's easy to raise a troubling picture for stocks. Prices could fall to the point where traditional measures such as price-earnings ratios sink to more typical levels. In the process, stock investors would take an early summer bath. DO ALL STOCK ANALYSTS SEE TROUBLE AHEAD? Many stock market analysts and money managers still are pinning their hopes on corporate earnings improving in the quarter that starts Wednesday, then finishing the year strong. Big earnings gains the next six months would go a long way toward making currently high stock prices a lot less scary to experienced investors. WHAT DOES IT LOOK LIKE FOR A TYPICAL STOCK? Du Pont has seen big earnings gains. The chemical giant earned $1.91 per share the past 12 months. Its stock sells for $50 1:2. That means its P-E is more than 26 - its stock price is 26 times earnings per share. That's pretty typical for stocks that are part of the Standard & Poor's 500 index. If Du Pont's stock holds steady at $50 1:2 and earnings rise 50% to $2.87 a share, the stock's P-E would fall to less than 18. WHAT HAS HAPPENED IN THE PAST? Maybe that will happen to Du Pont and all sorts of other stocks. But historically speaking, the odds are stacked against the stock market doing well from here. If earnings are everything, as some market followers say, then it may be time for stock investors to get ready for a shock. The price-earnings ratio on the Standard & Poor's 500 stock index, based earnings the past four quarters, is 25. That's nearly double the average price-earnings ratio for the S&P 500 since 1970. ARE THE BULLS CONCERNED ABOUT THE HIGH P-E? The bulls say the high P-E is nothing to worry about because it is based on depressed earnings of companies just coming out of a recession. They argue that as the economy improves, it will lift corporate earnings, and bring the S&P's P-E back in line with reality later this year. ARE THE BULLS BEING REALISTIC? But that hasn't happened since World War II when the S&P 500's P-E has been this high, says John McGinley, editor of Technical Trends newsletter in Wilton, Conn. McGinley has all sorts of studies he keeps close at hand that piece together a bleak outlook for stocks. One shows that the S&P 500's P-E has been substantially over 20 only three times since World War II: 1961, which was followed by a 25% decline in stock prices; 1987, when the October market crash knocked stocks down 23% in one day; and now. DOES MCGINLEY HAVE OTHER EVIDENCE? If that's not enough to stir a little concern, McGinley points out the P-E on the S&P was above 18 through both the first and second quarters this year. After rustling around for a minute, he produces a study that finds that the 12 other times the index's P-E has been above 18 two straight quarters, the S&P 500 typically was down 10% six months later, 16% lower after a year, and 19% lower after a year and a half. WHAT IS MCGINLEY'S OVERALL OUTLOOK? Finally, McGinley points to the average P-E of 13 for the S&P 500 since 1970. "That makes pretty sad reading when you calculate what it means," he says. Based on companies' latest 12 months of earnings, the S&P 500 would have to fall to about 212 - 48% below Tuesday's close - for its P-E to be 13. A similar drop would put Dow industrials at 1726. WHAT DO OTHER PEOPLE THINK? That kind of talk sounds alarmist to anyone banking on earnings coming back in grand style this year. The typical Wall Street analyst says earnings for the S&P 500 companies will soar 48% this year from very depressed levels last year. If investors didn't believe that, the stock market wouldn't have gotten to and held at the levels it has. A bunch of pleasant surprises among first-quarter earnings reports supported confidence that the profits news for companies will get better from here. WHAT IF INVESTORS ARE DISAPPOINTED WITH EARNINGS? There already have been plenty of examples how Wall Street is poised to treat disappointing earnings news. Companies such as Stride Rite, Borland and Dell Computer have seen anywhere from 10% to 25% whacked from their stock prices in a single day after reporting poor earnings or simply warning that earnings would not meet expectations. ARE THERE BETTER INVESTMENTS OUT THERE? Without the promise of better earnings to propel stocks higher, the feel-good bulls are forced to point to safety nets that will at least prevent the market from falling, if not provide a further lift. One popular rallying cry for people advocating a rush on the stock market this year is that there isn't anywhere else to put your money. The plunge in interest rates has meant returns on savings and yields on many notes and bonds seem pathetically low to most investors. The yields on money market mutual funds and certificates of deposit are near record lows. ARE STOCKS ALL THAT SAFE? But take a peek at what the investors who bought into the stocks-are-the-only-game argument got. Even after including dividend payments, the S&P 500 is down 0.65% this year. That could get a lot worse if there's one big sell-off. Plenty of investors have done a lot worse - especially those drawn to the market's hot spots late in 1991. For investors who chose the popular investing route of mutual funds, the average stock fund is down 4.4% for 1992. Maybe that 3.4% annual yield on a money market mutual fund isn't so unattractive after all. Bonus Editor: Ed Kelleher. (1-919-855-3491) Making copies of USA TODAY Update (Copyright, 1992) for further distribution violates federal law. This article is copyright 1992 Gannett News Service. Redistribution to other sites is not permitted except by arrangement with American Cybercasting Corporation. For more information, send-email to usa@AmeriCast.COM