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March 27, 2013 – Comments (1)

Board: Deranged Monkey Criticism

Author: howardroark

We've exhausted the Hussman Identity Theory debate. But beneath that fairly tale (and by that I mean axiom) lies an interesting prediction. -- that corporate profit margins are 70% above normal and will soon enough dramatically revert. This is a prediction that isn't at all inherently dependent on whether you buy the Identity story. It is interesting because it is seemingly wildly different from consensus. It is also interesting because this is not just a "hey, this is possible" sort of musing. More like a "people, this is happening" Mayan Prophecy kind of party, but doesn't require any kind of big shock to impose itself. And most interesting is that the outcome would of course have enormous investment implications on average.

The prediction, specifically, is that in the near future corporate profits will decline to just under 60% of current levels, and that this new level could then be seen not as trough but rather as "normal." Hussman, for example, describes one possible path where S&P profits decline 12% per year for four years toward a new normal. Recording predictions for posterity sometimes turns out to be pretty interesting when there are hugely heterogeneous beliefs on a quantifiable subject. I still go back every few years and look at the consensus Amazon predictions that were made on that board in the early 2000s. I feel like there may be an opportunity for that here.

I don't think there's a perfect way to phrase this question. I would like to capture both the basic prediction about corporate profits and the individual's confidence level. Here are the basic facts. S&P operating EPS in 2012 were about $101. At Hussman's "normalized" margins they would have been $59. He appears to default to a generic assumption that nominal EPS grows at about 6% per annum, though he also may believe that to be optimistic without high inflation. $59 growing at 6% nominally for 5 years would become $79 in S&P earnings in 2017. In contrast, $101 growing at 6% for 5 years is $135. Moreover, current 2014 estimates of $123 operating EPS growing at 6% for three years is $146. Of course, a big problem with making a prediction about normalcy is that a given future year might itself be abnormal. And even an average of a few years might be abnormal, particularly if one or two of the years experience an intense recessionary shock. But I'm not sure posterity will stick around long enough to take some kind of trimmed mean from 2017-2027.

So let's go with this: Make two predictions. First, predict the average operating EPS of the S&P from 2016 to 2018. This is just your best guess. Second, provide the level you are at least 75% sure is too high. That is, complete the sentence "There is less than a 25% chance that S&P operating earnings will average above X from 2016-2018." I will make mine after, say, ten responses in this thread. This is not because I think people give a crap about my guess and so will be desperately motivated to participate. It is because the rank humiliation from writing a long plea like this and getting maybe two responses will be mitigate if I can be both snubber and snubee.

If you find this exercise boring or stupid, that's a probably good reason not to play. But don't abstain merely because you don't think you've done enough navel gazing about "normal" earnings. Gut feelings about a topic like this can be interesting, assuming you are at least someone who follows and thinks about markets and companies. 

1 Comments – Post Your Own

#1) On March 27, 2013 at 12:58 PM, IlanBigfoot (65.34) wrote:

I think the market is undervalued, so let's say the S&P500 current price of 1,559.58 will go up 10% a year to $2511 by 2017. With a P/E of let's say 18, that would indicate earnings of ~$140.

 So: average EPS from 2016 to 2018 is $140. I'm 75% sure that earnings of $200 is too high. Did I say two? Better make it three. 

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