Comments on: Normalizing Earnings During Profit Freefalls http://www.ritholtz.com/blog/2009/05/normalizing-earnings/ Macro Perspective on the Capital Markets, Economy, Geopolitics, Technology, and Digital Media Tue, 14 Feb 2012 13:58:51 +0000 hourly 1 http://wordpress.org/?v=3.0.5 By: Onlooker from Troy http://www.ritholtz.com/blog/2009/05/normalizing-earnings/comment-page-4/#comment-173026 Onlooker from Troy Mon, 18 May 2009 23:40:02 +0000 http://www.ritholtz.com/blog/?p=26863#comment-173026 mdod Yes, but the problem with using some kind of normalized earnings (like PE10) at this point is that earnings over the last 10-20 years (especially the last 6 or so) have been pumped up and skewed by the increasing use of leverage in all parts of business. So how do we account for the shift to a much less leveraged world (and the transition to that; i.e. debt deflation) and figure out what earnings will be and how to value the market now? Or as Dr. Hussman says: "the Market Climate for stocks remained characterized by mixed valuations – modestly overvalued on the basis of most fundamental measures except those that assume a sustained return to the record profit margins of 2007, and slightly undervalued if one assumes that a return to those profit margins is a given." This extreme uncertainty is undoubtedly contributing to the current market volatility. Nobody has a real clue how to value things now or what the future holds, so we chase up and down. mdod

Yes, but the problem with using some kind of normalized earnings (like PE10) at this point is that earnings over the last 10-20 years (especially the last 6 or so) have been pumped up and skewed by the increasing use of leverage in all parts of business. So how do we account for the shift to a much less leveraged world (and the transition to that; i.e. debt deflation) and figure out what earnings will be and how to value the market now?

Or as Dr. Hussman says: “the Market Climate for stocks remained characterized by mixed valuations – modestly overvalued on the basis of most fundamental measures except those that assume a sustained return to the record profit margins of 2007, and slightly undervalued if one assumes that a return to those profit margins is a given.”

This extreme uncertainty is undoubtedly contributing to the current market volatility. Nobody has a real clue how to value things now or what the future holds, so we chase up and down.

]]> By: call me ahab http://www.ritholtz.com/blog/2009/05/normalizing-earnings/comment-page-4/#comment-172980 call me ahab Mon, 18 May 2009 21:41:39 +0000 http://www.ritholtz.com/blog/?p=26863#comment-172980 mdod- well said mdod-

well said

]]> By: mdod http://www.ritholtz.com/blog/2009/05/normalizing-earnings/comment-page-4/#comment-172978 mdod Mon, 18 May 2009 21:37:29 +0000 http://www.ritholtz.com/blog/?p=26863#comment-172978 The reason that guys like Leuthold, Shiller, etc. (and Ben Graham for that matter) use(d) normalized earnings is/was two sided…to keep you from being too pessimistic at/near market bottoms (PEs on the Dow went infinite near the bottom in the 30s…) and to keep you from being too optimistic when earnings are above trend at/near market peaks (and PEs look artificially low). And guys like Leuthold have tested market timing results that way, which are good from what I have seen of some of Leuthold’s studies. You want to remove the earnings cycle as best you can. (Operating earnings are used for that reason as well, although the argument against using operating earnings holds more water...) The question that we are trying to answer is forward looking not looking backward. So, analogies like "what my Batting Average would have been in High School if I excluded strike outs" or Tiger not having to take a penalty stroke for hitting one in the water don't apply as well. If we are trying to assess Tiger as a golfer, we don't extrapolate a horrible round. A better assessment would be to look at how Tiger has done on average. The reason that guys like Leuthold, Shiller, etc. (and Ben Graham for that matter) use(d) normalized earnings is/was two sided…to keep you from being too pessimistic at/near market bottoms (PEs on the Dow went infinite near the bottom in the 30s…) and to keep you from being too optimistic when earnings are above trend at/near market peaks (and PEs look artificially low). And guys like Leuthold have tested market timing results that way, which are good from what I have seen of some of Leuthold’s studies. You want to remove the earnings cycle as best you can. (Operating earnings are used for that reason as well, although the argument against using operating earnings holds more water…)

The question that we are trying to answer is forward looking not looking backward. So, analogies like “what my Batting Average would have been in High School if I excluded strike outs” or Tiger not having to take a penalty stroke for hitting one in the water don’t apply as well. If we are trying to assess Tiger as a golfer, we don’t extrapolate a horrible round. A better assessment would be to look at how Tiger has done on average.

]]> By: leftback http://www.ritholtz.com/blog/2009/05/normalizing-earnings/comment-page-4/#comment-172975 leftback Mon, 18 May 2009 21:27:54 +0000 http://www.ritholtz.com/blog/?p=26863#comment-172975 This makes so much sense that I am convinced that for the time being it is wrong: http://seekingalpha.com/article/138143-a-lose-lose-situation-for-long-term-u-s-treasuries This makes so much sense that I am convinced that for the time being it is wrong:
http://seekingalpha.com/article/138143-a-lose-lose-situation-for-long-term-u-s-treasuries

]]> By: call me ahab http://www.ritholtz.com/blog/2009/05/normalizing-earnings/comment-page-4/#comment-172971 call me ahab Mon, 18 May 2009 21:21:17 +0000 http://www.ritholtz.com/blog/?p=26863#comment-172971 by jawboning maybe they can keep the markets from deflating more- stagnant decade or more of economic growth ahead- all the while singing the "The Sun will Come out Tomorrow" by jawboning maybe they can keep the markets from deflating more- stagnant decade or more of economic growth ahead- all the while singing the “The Sun will Come out Tomorrow”

]]> By: leftback http://www.ritholtz.com/blog/2009/05/normalizing-earnings/comment-page-4/#comment-172970 leftback Mon, 18 May 2009 21:10:58 +0000 http://www.ritholtz.com/blog/?p=26863#comment-172970 They cannot support all assets, all of the time. They will have to alternate supporting equities and Treasuries. Or instead of actually doing so, simply jawbone the markets to suggest that they will do so. They cannot support all assets, all of the time. They will have to alternate supporting equities and Treasuries.
Or instead of actually doing so, simply jawbone the markets to suggest that they will do so.

]]> By: call me ahab http://www.ritholtz.com/blog/2009/05/normalizing-earnings/comment-page-4/#comment-172969 call me ahab Mon, 18 May 2009 21:09:14 +0000 http://www.ritholtz.com/blog/?p=26863#comment-172969 the great unknown is- how long the USG will slop up the markets with QE and reflation plays- years? Can they put a floor under all assets denying the market the abilty to clear efficiently- for months/years?Are we looking at a Nikki stlye future becuase of USG involvement or will the markets deflate regardless? The GD was called the Great Contraction by Friedman because of the contraction of the money supply- it appears the USG is trying what all theorists had put forth as a solution for deflation- QE- so how will it play out? the great unknown is- how long the USG will slop up the markets with QE and reflation plays- years? Can they put a floor under all assets denying the market the abilty to clear efficiently- for months/years?Are we looking at a Nikki stlye future becuase of USG involvement or will the markets deflate regardless?

The GD was called the Great Contraction by Friedman because of the contraction of the money supply- it appears the USG is trying what all theorists had put forth as a solution for deflation- QE-

so how will it play out?

]]> By: leftback http://www.ritholtz.com/blog/2009/05/normalizing-earnings/comment-page-4/#comment-172968 leftback Mon, 18 May 2009 21:09:12 +0000 http://www.ritholtz.com/blog/?p=26863#comment-172968 Paulson, H was the author of "Too Big to Fail", along with Blankfein, L. at the AIG bailout meeting. DL: Thanks, I missed that post. Seven lean years = 5 more years of the Bear !! batmando: I think the Irish are on the Euro, these days, they had to "punt" their old currency on joining the EU. Besides, if she's a good looking lass in Ireland, one smile = one free pint of Guinness. Universal exchange rate. Paulson, H was the author of “Too Big to Fail”, along with Blankfein, L. at the AIG bailout meeting.

DL: Thanks, I missed that post. Seven lean years = 5 more years of the Bear !!

batmando: I think the Irish are on the Euro, these days, they had to “punt” their old currency on joining the EU.
Besides, if she’s a good looking lass in Ireland, one smile = one free pint of Guinness. Universal exchange rate.

]]> By: hopeImwrong http://www.ritholtz.com/blog/2009/05/normalizing-earnings/comment-page-4/#comment-172967 hopeImwrong Mon, 18 May 2009 21:02:55 +0000 http://www.ritholtz.com/blog/?p=26863#comment-172967 I was just thinking what political influence can buy in America. Ask yourself this question. Why wasn't Enron bailed out? It wasn't because republican's don't bail out corporations. Too big to fail, you say? Who fed the Gov't the "to big to fail" excuse? It wasn't the FDIC, right? I was just thinking what political influence can buy in America.

Ask yourself this question.
Why wasn’t Enron bailed out?
It wasn’t because republican’s don’t bail out corporations.

Too big to fail, you say?

Who fed the Gov’t the “to big to fail” excuse? It wasn’t the FDIC, right?

]]> By: I-Man http://www.ritholtz.com/blog/2009/05/normalizing-earnings/comment-page-4/#comment-172966 I-Man Mon, 18 May 2009 21:02:41 +0000 http://www.ritholtz.com/blog/?p=26863#comment-172966 LOL Left... you're on fire today man. LOL Left… you’re on fire today man.

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