Lately, there has been a spate of research, analysis and commentary telling us that earnings are at a cyclical high and must revert. Stock valuations, therefore, are elevated and earnings will soon begin to fall, bringing stocks down with them.

This is neither a credible analysis nor a method of valuing equities. Rather, it is an interesting narrative containing two predictions, and generally fails to acknowledge multiple unknowns and variables. (Let’s hold the question of whether anything as complex as the markets can be predicted with a single variable for another time).

Allow me a few more words to explain. Many of the traditional valuation methods rely on two or more variables. For example, price-to-earnings ratio uses both stock prices and earnings to determine if a company or market is cheap or expensive. This raises the obvious problem — obvious to anyone who is not innumerate — of forecasting one unknown by using a second unknown.

Why is that? . . .


Continues here

Category: Earnings, Investing, Really, really bad calls, Valuation

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

3 Responses to “Why ‘Peak-Earnings Models’ Are Nonsense”

  1. peterkrause says:

    Can risk have a slope? I ask this question because in the recent post by Kiron Sarkar, he notes that the market has not had a correction in over a year, which “increases the risk that one is due.” So I want to know if you subscribe to the idea that risk increases or decreases, or that it has a definable trend, or slope. I know that if I flip a coin and it comes up heads, there is an equal “risk” that it will come up heads or tails next time. If, however, I buy a ten year old Renault Quatre at an auction in Amsterdam and try to drive it to Florence, I would assign the journey a positively leaning risk profile and bring at least one wrench.

    I accept your well written discussion about peak-earnings predictions. No quibbles. But we are all in the business of looking down the road, and in the Bernanke-driven jalopy that is this current bull-run, I feel like we are sloshing around a bit in the back seat, more and more wondering: “what’s that noise?”

  2. rd says:

    Speaking of coasts, new studies are showing that we have out-sourced the jobs but are receiving a percentage of the pollution they produce anyway:

    Chinese air pollution is making its way to the US West Coast, contributing to smog and acid rain. It s clearly diluted from the levels seen in china, but the trade wind patterns mean that inverse square law for dissipation doesn’t apply, so a reasonable percentage blows to North America, similar to the radioactivity and debris in the ocean from Fukushima.

    It would be nice to at least have the jobs if we are going to get the pollution.

  3. Peak-Earnings headlines are noise, but also necessary. If posted frequently enough, it could foreshadow a drop ahead.

    These metrics, cyclical peak/trough, etc. are all nearly meaningless right now. There’ s just ONE metric to watch: the end of QE, pressure for higher rates. No one knows when that will happen, but those who know what to look for might get a head start in exiting the market.