Breakout

As Profit Growth Stalls, Stocks Will Fall: Kee

Breakout

As weak as the markets have been for the past two months, Wall Street's bullish bias is fully intact, as traders, strategists and money managers still overwhelmingly maintain an optimistic long-term outlook for the stock market. And rightly so, given that Mr. Market has proven the bulls right again and again for more than 100 years. In fact, as I write, the average analyst is expecting a 10% gain for the S&P 500 next year, even though earnings aren't expected to grow half as much.

The difference, or extra return, can only come from one place, P/E expansion, or a higher price-to-earnings ratio, which is simply Wall Street's way of saying investors will be willing to pay more for a dollar's worth of earnings next year than they are today. It's also why strategists continually argue that stocks are cheap, especially when they sell off.

But what if stocks actually aren't cheap and the notion of P/E expansion doesn't pan out? That's the case Tom Kee, CEO and editor of Stock Traders Daily, makes in the attached video.

"People are talking about the multiple on the market and saying it's low compared to historic numbers," Kee says, adding that his research shows current earnings growth is tracking at 2.8%, which is less than half the pace of the historic long-term average of 7.1%. "So my question to everyone is: Does the multiple of the market need to fall to reflect slower earnings growth? I think the answer to that is yes."

If he's right, then next year's price targets would be in serious jeopardy.

"The true picture is that the Dow Jones Industrial Average — on both an earnings and revenue basis — is contracting, and no one seems to recognize that except for the big players in this market," Kee says, predicting that we are in for slower growth and lower markets. "What I'm looking for is continued deterioration in earnings growth, and that brings those multiples into question and, ultimately, risk appetite into question."

As far as any arguments go that the market is simply a game of expectations and that beating the street, so to speak, is all that matters, Kee counters by saying that kind of relative performance is dangerous.

"In all of my analysis I try to remove the comparison to expectations," he says. "Comparisons to expectations do not give you the true picture."

And so it's only fitting that a guy who sees ''meager'' earnings growth at best next year is on watch for multiple contractions, which is simply Wall Street's way of saying investors will be willing to pay less for a dollar's worth of earnings next year than they are today.

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