The Wall Street Parrot

There are many dangerous species of animals.  For investors, the most dangerous is the omni-present Wall Street Parrot (parietis vicus psittacidae).  This predator is especially dangerous because of his (or her) appearance -- attractive, well-dressed, and fluent in the language of Wall Street truthiness.

Here are some key characteristics:

• Fully conversant in the headlines of the day.
• Specializing in telling you what you already (think) you know.
• Carefully avoiding any data.  Citations vague, with no ability to test or verify.
• Extreme and aggressive statements.

You can see the Parrot on most financial TV programs.  Ratings are good when readers are reinforced in what they already believe.

Current Examples

This species is definitely not on the endangered list.  The parrots are out there in force pretending that they know exactly what will happen in Europe and basically selling fear.  A careful look at the background shows that they are selling something:  gold, bond, and "structured products."  [Full disclosure:  I am long GDX and bond ETFs in client accounts.]

Let's try this out.  Since I have not implemented audio, you will have to use your own parrot voice.

Earnings must come down. Earnings must come down.

The Fed is printing money.  The Fed is printing money.

[I invite reader suggestions for more parrot comments.  Maybe we should also have a parrot Hall of Fame.]

A Knowledge Test

If there were a simple knowledge test, the parrot would know nothing more than a bird.  None of these guys who talk about money printing could explain what happens in a fractional reserve banking system.  They also could not show what happened with the proceeds of the Fed purchases under QE II.  They could not name the members of the European Union, although they can talk fluently about the PIIGS.  Basically, they do not know anything relevant, but they sound smart.  Since they are saying something that resonates with viewers and readers, they get a lot of attention.

Similarly, those who confidently say that "earnings must come down" use a simple heuristic.  There have been some soft economic data points.  We all "know" that analysts are too optimistic despite strong evidence to the contrary.  Conclusion:  Bombs away for the market.

The Hidden Assumptions

Josh Brown has a nice piece where he highlights this as the big question.  I make it as one of three big questions (Europe and the false hope of QE 3 are the other two), but Josh is on the right track.

Here are the key points:

• The parrots have been wrong for several quarters -- some of them for years.  There should be a statute of limitations on credibility.
• Since past GDP was revised down, we now know that great earnings growth was accomplished in spite of modest economic growth.  Forecasts are for better, yet modest, growth.  Why must earnings be lower?  It seems like things are getting better from this low base.
• But wait!  Many of the parrots are building a recession into their forecasts.  Since a recession is unlikely, their forecasts will probably be wrong.
• There is a lot of room for slack. 2012 earnings on the S&P 500 are estimated in the $100-110 range.  One of the parrots said today that he is "in the mid-70's."  No justification or analysis, just his opinion.  What if the actual number is $92?  We are still looking at a cheap market.
• What is "baked in?"  The low PE on forward earnings reflects intense skepticism about the future.  While it is difficult to prove, the data suggest a high level of current skepticism.

Conclusion

People seem to love to argue about market valuation.  Much of the commentary features methods that never give a buy signal -- not too useful in practice.

Since the basis for these arguments are earnings, let us talk dividends instead.  Many of the current articles demonstrating that we have a cheap market are using the attractive dividend yield compared to the 10-year Treasury Note, formerly viewed as risk free.

Here is a good parrot challenge question:  Do you expect the Dow Stocks to be cutting dividends?  If so, which ones?

Resources

In my weekly summary article, I highlighted a piece that everyone should read, The Fat Pitch.  Here are some other great resources.

• Felix Salmon -- earnings yield divergence.
• Dr. Ed -- looking sector by sector.
• Bonddad -- look at the great dividends
  AT&T 6.28% Verizon 5.94%
  Merck 5.10%
  Pfizer 5.04%
  Intel 4.37%
  General Electric 4.24%
  Johnson & Johnson 3.87%
  Procter & Gamble 3.74%
  Dupont 3.66%
  Home Depot 3.65%
  Kraft Foods 3.54%
  Chevron 3.51%
  Wal Mart 3.36%
  McDonalds 3.15%
  Coca-Cola 3.03%
  Microsoft 3.02%
  Boeing 3.00%
• Warren Buffett - Buying a falling market.

I urge readers to check out these sources.  None of us has a guarantee that markets will move higher in the next few weeks, but at least we have reason and data on our side.

[disclosure -- in addition to stocks previous mentioned, we own Intel, Microsoft and Boeing in various accounts.  We are actively looking at other stocks on the dividend list.]

 

Comments

[Todd L]

Great post Jeff - my comment has more to do with the link through to your post on analyst's ability to forecast earnings 1 year out. Your general conclusion was that analysts were actually pretty good at 1 year forecasts. It looked to me like that was fair, but that you could also just as easily conclude analysts just play it safe with their forecasts and predict little in the way of change.

During an expansion, from the chart your show, it seems like they underestimate earnings. During a contraction/recession, they seem to overestimate earnings. And at inflection points, they seem really bad (2008, Lehman).

It's admittedly not much data to go off of. But I guess I would just be a little cautious using analyst earnings forecasts to support conclusions about the valuation of the market right now, especially since it seems like there is some evidence that we are nearing an inflection point.

[Dal Paull]

I knew I'd like this when I saw "....Wall Street Parrot (parietis vicus psittacidae)" The article is delightful. Kudos to the Old Prof and the (ahem) extensive "A Dash" research staff.

[wsm]

"Many of the parrots are building a recession into their forecasts. Since a recession is unlikely, their forecasts will probably be wrong."

Not so sure about this. For one, most of the "parrots" that I have had a chance to read are calling for the U.S. to AVOID another recession. As you pointed out, no reasons are offered, just the naked opinion. Secondly, do you really think a recession is unlikely? I would cite John Hussman's latest missive:

"The composite of recession warning evidence we observe here falls into a Recession Warning Composite that has been observed in every recession since 1950, and has never been observed except during or immediately preceding a recession." Hussman's methods are data-intensive, and should not be dismissed, in my opinion.

Regardless, I certainly concede that you correctly point out that corporate earnings can (and indeed, have already) grow while economic readings continue to be horrific. But I would argue that the economic backdrop is largely responsible for the lower multiple being assigned to said earnings. Until the economic backdrop improves, multiple expansion will be hard to come by.

So, while there are certainly individual stock opportunities aplenty, it is pretty tough to argue that "there is a lot of room for slack" from a market-wide perspective.

[Andrew H]

Parrot speak:

We are running out of options, we are running out of options

Its a dead cat bounce, its a dead cat bounce

We're heading foe a double dip, we're heading for a double dip

We're all doomed, we're all doomed.

[Proteus]

"...the 10-year Treasury Note, formerly viewed as risk free."
Best line I've read this week; I'm still laughing.

And I expect Apple to be slashing their dividend in the not too distant future. (my attempt at humor)

[PeteB]

"None of us has a guarantee that markets will move higher in the next few weeks, but at least we have reason and data on our side."

Of course, the data was on your side three weeks ago as well.

If valuations exert such a weak gravitaional force on stock markets (certainly in the short-term) then isn't it possible that prices could move still lower in the next few weeks?

And is a recession still unlikely? How unlikey? Is a recession more likely today then it was three weeks ago?

Regards