Upbeat Analysts Ignore Bumps in Road

The Wall Street Journal

If the recovery is in danger, it is news to analysts.

They have maintained a surprisingly rosy view of U.S. corporate earnings despite the market's recent pullback on growth concerns. Current estimates put the S&P 500 on track for earnings per share of $85.26 this year, according to Thomson Reuters, a return to 2007 levels. Analysts' $96.61 forecast for 2011 earnings would mark a record that surpasses the 2006 peak.

If that pans out, stocks look like a buy going into the end of the second quarter. After May's sell-off, the S&P 500 is trading at about 12.8 times estimated 2010 earnings, compared with a historical average of about 15 times.

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What, then, is hobbling stocks? Worry over deflation, deficits and decelerating growth has damped hopes for a robust recovery. As a result, "investors are demanding a higher premium for their perceived higher risk," says Brian Bethune, chief U.S. financial economist at IHS Global Insight.

Plus, analysts' relative optimism offers little comfort to some, given the group's forecasts often trail the market.

"They're pretty good at anticipating earnings when the economy is expanding," says Ed Yardeni, president of Yardeni Research, "but they typically don't see recessions coming." Current valuations also are well above troughs seen in 2008 and 2009.

Still, it may be a mistake to dismiss analysts' views entirely. After all, U.S. corporate profits are in the midst of a powerful rebound, rising 31% in the first quarter over the same period in 2009, the most since 1984, according to Barclays Capital. The cyclical upswing "will be strong enough to overcome the headwinds" from Europe's debt crisis, say Barclays economists, who expect the U.S. economy will expand about 3.4% this year.

And, while risks to this recovery have grown, the economy is still behaving as if it is in the early stage of expansion, rather than the tail end. Analysts' better track record during expansions may mean there is less risk that their optimism is misplaced.

Indeed, analysts have ratcheted up estimates as the year has progressed, rather than stepping back from an excessively optimistic start, as is usually the case. If they hold their ground, stocks may have an easier time regaining their composure.

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