Bears Overwhelm Bulls Buying Cheapest S&P 500 Since Reagan Era

By Eric Martin and Michael Tsang

Nov. 24 (Bloomberg) -- Buying the cheapest U.S. stocks since Ronald Reagan’s presidency may be a sucker’s bet.

Investors are paying $9.24 per dollar of operating profit forecast in 2009 for Standard & Poor’s 500 Index companies, half the two-decade median of $18.10, data compiled by Bloomberg show. While that may suggest shares will bounce from the worst annual drop since 1931, managers at Key Private Bank, Morgan Keegan and the Hartford say equities may keep falling as earnings trail Wall Street estimates for 14 percent growth next year.

Companies from New York Times Co. to Tesoro Corp. could prove expensive based on next year’s profits after results missed forecasts by more than 20 percent in 2008. S&P 500 earnings have decreased for five straight quarters, the longest streak since the 2001 recession, when U.S. stocks fell for seven more months after profits bottomed, according to data compiled by Bloomberg. The same pattern would leave U.S. stocks mired in a slump for another year.

“Markets tend to come off major sell-offs much more slowly than you anticipate,” said Bruce McCain, chief investment strategist at Key Private Bank in Cleveland, which manages $30 billion. “Earnings will show the same stresses. You need to stand aside and not catch the falling knife.”

Stock valuations suggest S&P 500 profits may decrease as much as 42 percent next year amid forecasts for the worst recession in more than two decades. Profit at non-financial firms will decline 9.2 percent this quarter, the first drop in almost seven years, just as analysts predict banks, brokers and insurers begin to recover from almost $1 trillion in losses globally.

Bait and Switch

Companies that appear inexpensive may not be. New York Times, publisher of the namesake newspaper, fetches 9.73 times analysts’ forecasts for 2009 profit, the lowest price-earnings ratio in 15 years, based on monthly data compiled by Bloomberg.

The New York-based company, which missed estimates by 22 percent in the past four quarters, would trade at 12.4 times next year’s earnings if analysts estimates prove similarly high.

Tesoro, the biggest oil refiner in the U.S. West, trades for 5.2 times next year’s estimated earnings, data compiled by Bloomberg show. The valuation more than doubles when next year’s projections are reduced by the 51 percent by which Tesoro fell short of analysts’ forecasts in the last four quarters.

Catherine Mathis, spokeswoman for New York Times, and Sarah Simpson, spokeswoman for San Antonio-based Tesoro, declined to comment.

The S&P 500 slumped 8.4 percent to 800.03 last week, wiping out almost all the gains from a five-year bull market that ended Oct. 9, 2007. The benchmark of American equities has plummeted 49 percent, making the 13-month bear market the second-worst since the 1930s, data compiled by Birinyi Associates Inc., a Westport, Connecticut-based research firm, showed.

Smallest Premium

Based on last week’s closing price, S&P 500 companies are trading at 9.24 times profit from continuing operations of $86.59 for 2009, using analysts’ estimates compiled by Bloomberg. That’s the smallest premium investors have ever paid for future earnings and the cheapest compared with historical income since 1988, based on data compiled by Bloomberg and S&P.

Investors are paying so little because analysts are probably wrong, John Wilson, co-director of equity strategy at Memphis, Tennessee-based Morgan Keegan, which manages $120 billion, said.

Estimates have overshot actual results by an average of 11 percentage points in the past five quarters, based on consensus projections compiled by Bloomberg before the start of each reporting season. Analysts have become increasingly inaccurate and missed last quarter by 15.4 percentage points.

Missing the Mark

On Sept. 26, analysts called for a 3 percent decline in third-quarter earnings. With 96 percent of S&P 500 companies reporting, profits have fallen 18.4 percent.

Bank of America Corp., the largest U.S. retail bank, said last month that third-quarter profit dropped 77 percent to 19 cents per share, versus the 61-cent average estimate of analysts surveyed by Bloomberg. Three days later, Richard Bove, Ladenburg Thalmann & Co.’s financial analyst, cut his profit estimate for 2009 by 28 percent and his 2010 estimate by 16 percent. The Charlotte, North Carolina-based lender has lost 64 percent of its value since its Oct. 6 earnings announcement.

Boeing Co., the world’s second-biggest commercial aircraft maker, said that per-share operating profit tumbled 35 percent to 94 cents, falling short of estimates of $1.01, and said it wouldn’t be able confirm its previous profit predictions.

“If you look at the studies that try to equate analyst estimates with reality, you find a huge discrepancy,” said Wilson at Morgan Keegan.

‘Horrific Nightmares’

Wells Capital Management Inc.’s James Paulsen says share prices have fallen so much that stocks are a bargain even if analysts ratchet down their profit estimates.

About 96 percent of S&P 500 stocks have declined this year, dragging down all 64 industries within the benchmark index. Twenty-eight industries lost at least half their value in 2008 as the S&P 500 slumped to an 11-year low last week.

“The reality will turn out far better than people’s horrific nightmares they have priced in,” said Paulsen, chief investment strategist at Minneapolis-based Wells, which manages $220 billion. “We left the fundamental ranch a long time ago.”

This quarter, analysts expect profits at S&P 500 companies to increase by 4 percent. Getting there hinges on a sevenfold jump in profits at financial firms such as Citigroup Inc., which lost $20 billion in the past four quarters as bad loans increased and demand for banking services declined.

History Lesson

The New York-based lender, forecast by analysts to earn 74 cents a share next year, has fallen 87 percent in 2008, tumbling 60 percent last week alone. Citigroup and U.S. regulators are in talks about a plan to limit the bank’s potential losses from toxic assets after a crisis in confidence erased half the bank’s market value in three days, people familiar with the matter said.

Even if companies report higher profits this quarter, history shows that stocks may not rebound until the second half of 2009. After the bursting of the technology bubble in 2000, S&P 500 earnings fell from the first quarter of 2001 through the first three months of 2002. The index, in the midst of a bear market that wiped out 49 percent of its value, continued to fall for almost seven months until reaching its nadir on Oct. 9, 2002.

“The question is will growth pick up to warrant the earnings part of the valuation,” said Quincy Krosby, Hartford, Connecticut-based chief investment strategist at the Hartford, which has $416 billion in assets. “It’s probably later rather than sooner.”

To contact the reporters on this story: Eric Martin in New York at emartin21@bloomberg.net; Michael Tsang in New York at mtsang1@bloomberg.net.