The Great PE Multiple Expansion Of 2011-2014: Why The Market Must Eventually Crater

The earnings season is all over except for the shouting, but the outcome doesn’t remotely validate Wall Street’s happy times narrative. Reported Q4 earnings for the S&P 500 companies (with about two-thirds reporting) stand at $25.02 per share compared to $26.48 in the year ago quarter. That’s right. So far Q4 profits are down 5% but shrinking corporate profits is something that you most definitely have not heard about on bubble vision.
That’s because the talking heads invariably reference ‘adjusted’ or ‘ex-items’ earnings, which, almost by definition, exclude charges for every imaginable business mistake and bonehead executive action – -such as soured M&A deals and ‘restructuring’ expense – – that could possibly cause earnings to go down. For the four-year period 2007-2010, as I outlined in the Great Deformation, the ex-items profit figure hawked by the Wall Street analysts was a cool one-half trillion dollars or 30% higher than the GAAP profits reported to the SEC on penalty of jail time.
But that’s just the tip of the iceberg. The real truth coming out of this earnings season is that we have had a tremendous inflation of PE multiples during the last three years in anticipation, apparently, of the US economy hitting escape velocity and the overall global economy continuing to power onwards and upwards. As is evident from the financial news and ‘incoming’ data, however, that presumption is not remotely correct.
So when Wall Street calls a great multiple expansion party that doesn’t pan out – – what happens next doesn’t require a labored explanation. The untoward course of market action in the year after 1999 and 2007, respectively, speaks for itself. But the point here is that the eventual market correction this time could be a doozy. The magnitude of PE multiple expansion triggered when the Fed and other central banks went all in with ZIRP and QE has been enormous, and it has also gone largely unremarked upon.

This post was published at David Stockmans Contra Corner by David Stockman ‘ February 4, 2015.