I’ve had it with this nonsense about the market heading higher because results (either economic data or corporate earnings) are being reported as “better than expected.”  And in a more honest assessment, when someone concedes that it’s more like “less bad than expected”…well that may be more honest, but not any more insightful.

If you missed my rants on this topic before, you can find some of them here:

Tactics July 21, 2008

Fundamentally Flawed July 19, 2008

Less Negative Than Expected May 02, 2008

Analyzing Analysts April 18, 2008

How Good Is Earnings Season? April 30, 2007

How, When And Why Were Earnings Revised? April 25, 2007

Whether you read through those posts or not, please consider the dates when they were written.   The last time I heard as much bullshit about earnings being “better than expected” or “less bad than expected” was just prior to the market crumbling the first time (S&P 500 at 1500) and then just prior to the market crumbling the second time (S&P 500 at 1250).  I hope this association does not get reinforced with another selloff now.

But the reality is that analyst expectations for individual companies’ earnings are flawed and so are the estimates for the composite S&P 500 earnings.   The idea that investors get excited about a company beating pathetically wrong estimates with results that suck even worse than the analyst’s guesses is embarrassing.

Let’s evaluate the consensus estimates for the S&P 500.  At the end of 2007 when we were 6 months into this disaster, S&P 500 earnings for 2008 were expected to be about $102…over 15% higher than 2007.   BRILLIANT!!  Actual 2008 earnings?????? $49.51  Sorry….but that is not impressive to me.   Not the analyst performance and not the corporate performance.   Both sucked.  So forgive me if I am not playing along and cheering when analysts set estimates so low and companies manage to deliver crappy results that beat those pathetic estimates.  Reality was that the 4th quarter of 2008 was the worst earnings (loss) season on record.   The first quarter was terrible as well with about a 40% year-over-year decline.  Those are the facts and I don’t care how they are spun as some sort of optimistic bottoming process.

And by the way….analyst estimates did not set my expectations for stocks.   Did they set yours?   Do you really base your investing decisions upon your beliefs in the consensus estimates of these guys?   I hope not.

The financial entertainment channels and quite a few bloggers will try to impress you with statistics like “66% of companies reporting so far topped estimates, compared with 61% historically.”   Sounds impressive!?!?!  According to this selective analysis, we must be “bottoming” or “putting the worst behind us” or at least “leveling off”.    I have heard that quite a few times over the past 2 years and again recently.  Nice spin but what about the facts?

Here is an important question.   If analyst estimates are the primary basis for setting expectations, WHEN do you set those expectations? 1 day before earnings are announced?, 1 week before?, 1 month before?, 2 months before?, 3 months before?  You need to decide what’s reasonable.  If you buy stocks based upon fundamentals and the PE being quoted at any moment in time, do you constantly monitor the estimates and just adjust your expectations?   I don’t, but somebody must or this whole concept of fundamental-only investing and relying upon analyst estimates is a giant sham.  In fact, to buy into the bigger notion that the crappy earnings season we just went through was “better than expected” there has to be millions of investors believing in analyst estimates and building expectations upon them.

Supposedly, as analysts lowered estimates investors either sold stocks due to their disappointment of prior expectations or they just sucked it up and held while lowering their expectations.   Then, when earnings were announced and things were “better than expected” investors either stopped their selling, continued holding or created excess demand for new share purchases and voila…higher stock prices.   Seems obvious and logical right?   Well, it is if you really are predisposed to believe that is what happens or what should happen or what happened this past quarter.   But what about the facts?   What about your own experience over the past 3 months?   Do you really sell stocks every day that analysts give downward revisions?   Do you really evaluate your expectations every day and make buy, hold or sell decisions on them?  I am not talking about some loose assessment of your tolerances for being disappointed, satisfied or positively surprised.   The way this concept is sold, expectations are solidly known and evaluated at all times by some mythical force known as the “CONSENSUS”.  Who the hell are these people we call the “CONSENSUS”?   They must be millions of investors who totally agree about every average estimate of analysts often resulting from widely different high estimates, low estimates and standard deviations.   But somehow this magical group is able to come to agreement about the average, then form an opinion as to what is acceptable or not and then make the appropriate buy, hold or sell decisions.   For the record, I am not part of the “CONSENSUS” and I am proud of that.

Let’s say you are a member of that brilliant group, if your expectations for earnings were not met AND THE STOCK PRICE GOES HIGHER ANYWAY….do you sell?   I don’t think most people do that.   But it certainly messes with your head full of expectations doesn’t it?  This is when the rationalization known as “the bad news is already priced in” becomes popular.   We always need to excuse one flawed concept with another flawed concept so as to not have to address the first failure.   But anyway….

In Q1 (the most recent quarter), which has been lauded as “much better than expected” or “less bad” and has bugged me enough to write a post for once…I often took a quick look at where estimates were 60 days earlier.   Why 60 days?   Because that was right about when the market started heading higher.   Anyway, it was usually the case that estimates had declined dramatically in the prior 60 days.   HMMMMM!?!  Estimates down while stock prices went up.  Yet, when earnings came out, suddenly the media wants you to cheer a company that “beats.”  Okay, go ahead and cheer.  But please don’t buy stocks on that nonsense.

Here are the facts.   If you set your expectations about earnings of companies in the S&P and you set them 3 months prior to the actual results were announced, you’d probably be considered a long term investor these days.  Regardless, if you bought a stock based upon analyst estimates at the start of the quarter you’d most likely be very disappointed.   Only 30% of S&P companies actually beat earnings estimates that were about 90 days old and not only that but the 70% that missed the old estimates missed them by a lot.

Not fair you say???? After all, you might point out that stocks declined dramatically from mid-January to early-March.   Okay, I’ll play that game.   It’s true that analyst estimates got whacked from January until the end of February for about 80% of the stocks in the S&P and I can see the desire to associate declining expectations with selling and lower stock prices.   But what about the facts?   The facts are that if you look at the estimates that were in place on February 27, 2009….just days before stocks supposedly “bottomed”…the estimates that had been revised much lower than at the start of the quarter….well the logic from a few sentences ago gets blown to hell.

If you built your expectations based upon 2/27/09 estimates, only 45% of the S&P stocks ended up beating those lowered estimates.  So did you sell?  Did the CONSENSUS sell?   As expectations were low back then what explains the massive rally that began just a few days later?   Don’t tell me it was “better than expected earnings” because the quarter was only 2/3rd done.   And don’t tell me that estimates stopped getting worse during March?  In fact, during the last month of the quarter, 46% of the companies in the S&P had their estimates dropped again.   Following the previous fundamental logic, it just doesn’t work.   Although I am sure that people far smarter than me well-steeped in perpetuating how markets price assets will find a way to tell me I am wrong.

Regardless, analysts kept dropping estimates after March 31, 2009 and they did so right up to earnings were announced.   So once again, forgive me if I don’t believe in the entire concept that suggest stocks went up based upon 66% of S&P companies having results that were better than expected.   Stocks went up but in my opinion, it wasn’t based upon beating expectations.

If increasing stock prices are dependent upon analysts that are chronically wrong, we have flawed expectations.

If increasing stock prices are dependent upon analysts dropping estimates dramatically throughout a quarter so that a company has a tough time not beating, then we have flawed expectations.

If increasing stock prices are dependent upon the media and bloggers spinning shitty results as better than shitty estimates, then we have flawed expectations.

Regardless, we shouldn’t just be focusing on flawed expectations for earnings.   Are we really that one-dimensional?   Are we  paying attention to our expectations for revenues that (oh by the way missed the majority of the time last quarter) or expectations for cash flow or any other fundamental valuation metric for that matter?

What else is affecting our expectations?   Are you convinced the government is going to fix things with another bailout or changing mark-to-market or reinstating the uptick rule or monetary policy or fiscal policy or some other tactic?  Do you really believe the pathetic economists that are as chronically wrong about macro economic statistics as the analysts are about corporate estimates?   Most of them didn’t create correct expectations about the possibility, timing or extremity of the crisis we are in but suddenly people are supposed to believe their forecasts about green shoots or the improvement in the economy they are seeing. Maybe it’s CNBC cheerleading and hyping “better than expected” this or that.

If you have heightened expectations for a V-recovery in the market that supposedly began in March and an economic recovery by the end of 2009, what are those expectations based upon?  Let me ask a few questions that I hope you have factored into a more comprehensive basis for your expectations.   I don’t want to hear your answers, I just hope you have them.  So here goes:

How did the Bear Stearns bailout work?

How did the AIG bailout work?

How did the Fannie and Freddie bailout work?

How did all those government foreclosure avoidance programs like HOPE NOW work out?

How did TARP work?

How will the PPIP work?

How successful was Bernanke with his market manipulations?

How have all the forced mergers like BAC Countrywide and Merrill worked out?

How helpful was the stress test?

Were all the toxic assets fixed just by changing mark-to-market or announcing PPIP?

How did the first stimulus plan work out?

How did the recent stimulus plan work out?

How cheap is the market based upon the crappy estimates we are supposed to believe?

Do you have good expectations for interest rates?

Do you have good expectations for taxes being lower?

Do you have good expectations for budget deficits declining?

Do you have good expectations for lowered government spending?

Do you have good expectations for house appreciation?

Do you have good expectations for lowered foreclosures?

Do you have good expectations for low unemployment?

Do you have good expectations for wage rates increasing?

Do you have good expectations for private equity deals getting refinanced?

Do you have good expectations for credit card debt reductions?

Do you have good expectations for commercial real estate, aka CMBS?

If the US has bottomed, has Europe?

Do you expect the dollar to stabilize or not crumble?

There are a lot of flawed expectations floating around this market and sooner or later, we will pay the price for it.

HEDGEfolios year-to-date stock performance for 2009 (through 05/29/09 close) was up 53.61%.

Over the same time period, the S&P 500 index was up 1.79%.

At the end of May, the HEDGEfolios universe consisted of 3,199 stocks.

Commentary: Each time I see signs of a directional change (down) to the market, they rapidly reverse and we get a rally.   Nonetheless, the very light volume is concerning and it will not take much of a catalyst to begin a rollover.  Until then, I am still hanging onto a bullish bias.  At the end of May, 70% of stocks covered by HEDGEfolios had an UP signal and they have contributed greatly to the 53.61% YTD performance.

Here is a chart showing the performance of HEDGEfolios vs. the S&P 500:

Prior Years’ Performance:

• 2008, HEDGEfolios performance was +30.51% vs. -38.47% for the S&P 500 index
• 2007, HEDGEfolios performance was +21.78% vs. + 3.55% for the S&P 500 index
• 2006, HEDGEfolios performance was +25.54% vs. +13.62% for the S&P 500 index
• 2005, HEDGEfolios performance was +19.99% vs. + 3.00% for the S&P 500 index
• 2004, HEDGEfolios performance was +31.19% vs. + 9.00% for the S&P 500 index

Disclaimer: Nothing in my performance quoting is intended as an advertisement or in any other way meant to encourage anyone to subscribe to HEDGEfolios. These performance figures have not been audited or verified by an outside party and are NOT in compliance with the CFA’s AIMR Performance Presentation Standards. They don’t net out any transaction costs such as commissions or management fees and are not a total return calculation as I do not include dividend yields or any compounding factor. These performance figures cover a hypothetical portfolio of the entire HEDGEfolios stock universe with an equal weighting of each security. The calculation is simply the cumulative total of all gains and losses from the signals during the period in question.

Remember when the Bush/Cheney team was constantly accused of pushing up gasoline prices from the beginning of their administration?   After all, they had all those oil contacts, oil investments, oil buddies, etc. etc.  Democratic members of Congress wrote reports and publicly complained about it.   The liberal media was convinced of conspiracy with the Cheney Task Force and demanded to know who was involved in those secret White House meetings.

Does anyone remember how long after Bush’s first inauguration day until gas prices had risen 21%?

Click here for the data source.

What was the average price during that period (from inauguration until it was 21% higher) and compare that to the inauguration day?  Was the average lower, higher or about the same as inauguration day?

Now do the same for the Obama administration since their inauguration day.

HEDGEfolios year-to-date stock performance for 2009 (through 04/30/09 close) was up 42.06%.

Over the same time period, the S&P 500 index was down -03.34%.

At the end of April, the HEDGEfolios universe consisted of 3,209 stocks.

Commentary: While the S&P 500 advanced 9.39% in April, HEDGEfolios increased 19.6%.   This is the best HEDGEfolios has ever done over a single month.   The outperformance was primarily due to the large gains that were found in many stocks covered by HEDGEfolios that were not members of the S&P 500.

I am patiently waiting for a change to a downward direction.

Good luck with your investing.

Prior Years’ Performance:

• 2008, HEDGEfolios performance was +30.51% vs. -38.47% for the S&P 500 index
• 2007, HEDGEfolios performance was +21.78% vs. + 3.55% for the S&P 500 index
• 2006, HEDGEfolios performance was +25.54% vs. +13.62% for the S&P 500 index
• 2005, HEDGEfolios performance was +19.99% vs. + 3.00% for the S&P 500 index
• 2004, HEDGEfolios performance was +31.19% vs. + 9.00% for the S&P 500 index

Disclaimer: Nothing in my performance quoting is intended as an advertisement or in any other way meant to encourage anyone to subscribe to HEDGEfolios. These performance figures have not been audited or verified by an outside party and are NOT in compliance with the CFA’s AIMR Performance Presentation Standards. They don’t net out any transaction costs such as commissions or management fees and are not a total return calculation as I do not include dividend yields or any compounding factor. These performance figures cover a hypothetical portfolio of the entire HEDGEfolios stock universe with an equal weighting of each security. The calculation is simply the cumulative total of all gains and losses from the signals during the period in question.