Current P/E Ratios May Be Misleading

As we came into earnings season, it seemed clear that analysts were far too pessimistic with their estimates for earnings. Yesterday, Bloomberg reported that 81% of corporations have beaten earnings estimates. That’s the highest percentage since 1993.

Bloomberg also reported that the S&P 500 is now trading at 22 times reported earnings. That’s the highest P/E for the S&P 500 since 2002.

We might assume from this P/E that stocks are overvalued and due for a correction. But that might be a mistake. In 2002, stocks made their final bottom following the Internet bubble and 9/11. The S&P broke below 800 twice in 2002 (July and October) and traded down to 806 on February 13, 2003.

By the end of 2003, the S&P 500 had rallied to 1,112, a 37.9% gain.

*****Price to earnings ratios are often inflated when stocks are bottoming. In 2002, according to the very nifty P/E indicator at BigCharts.com, the P/E for the S&P 500 ranged between 27 and 42. And even in 2003, the P/E ranged between 26 and 35. It wasn’t until the end of 2004 that we started to see the P/E for the S&P 500 drop below 20.

What does this mean? It means we shouldn’t read too much into P/E ratios. P/E ratios are lagging indicators. They tell is what earnings were, not necessarily what earnings will be.

Right now, investors are saying they see more improvement in earnings ahead.

*****It’s happened to all of us. We accidentally overdraw our checking account while using our bank card, and then we get nailed with a series of overdraft fees.

Well, no more. Bernanke says that banks can no longer allow their customers to overdraw their accounts with debit cards — and be charged overdraft fees – unless customers opt-in to the program.

It may not sound like a big deal, but banks took in nearly $37 billion in overdraft fees in 2008. And even this year, when unemployment has devastated some family budgets, banks may take in $38.5 billion in overdraft fees.

In light of the fact that the Fed and the Treasury have done as much as they can to make it as easy as possible for banks to earn money, this is a surprising move. But it’s a good move. At $35 a pop, overdraft policies look almost predatory.

*****J.C. Penney (NYSE: JCP) reported earnings this morning. Revenues and earnings were lower than last year’s third quarter, but then we expected that. The surprise was that Penney’s raised full year revenue and earnings expectations.

An even better earnings report came out at Abercrombie & Fitch (NYSE: ANF). Abercrombie beat estimates by a wide margin, even though same-store sales dropped by what must be one of the biggest margins in retail – 22%.

Again, we must remember that earnings estimates were very low for the third quarter. Companies should beat. And if they don’t, it’s a very bad sign. Still it’s good to see improvement in retail. I still think there could be upside surprises for holiday spending.

*****Now, here’s TradeMaster‘s Jason Cimpl with our weekly video analysis of the markets. It’s free. Click here to view it.