What’s The Worst That Could Happen?
Via ConvergEx’s Nicholas Colas,
The 30 stocks of the Dow Jones Industrial Average currently trade for an average of 14.8x next year’s consensus earnings. But… Everyone knows Wall Street analysts are always too optimistic, so what if we just look at the lowest estimate for each company? That “Worst Case scenario” P/E is 16.7x – not “Cheap”, but not crazy expensive either – and incorporates a decline in earnings from 2015 of 1.5%.As tempting as it is to say “Buy stocks” with this math, the truth is hazier. In reality, markets currently discount this “Worst case” as the “Base case”. With the 10 year Treasury yielding 2.1%, that 16.7x multiple is where stocks should actually trade.
The driver of this market pessimism sits at the top of the income statement – the Street’s worst case revenue estimates call for a decline of 1.7% in 2016. Now, Q3 earnings season is unlikely to provide much comfort here; why should corporate managements go out on a guidance limb when their stocks are down on the year? All this points to further volatility in October, and with a bias to the downside.
Of all the words of tongue or pen, the dumbest are these: “What’s the worst that could happen?” I imagine every stupid stunt ever uploaded to Youtube started life with that question. Skateboard off the roof of your parent’s house into the pool… Taunt the chimps at the zoo… Jump a bike over 17 of your friends… That phrase is cursed. Even a movie of the same name, starring Martin Lawrence and Danny DeVito, only has a 10% approval rating on Rotten Tomatoes.
In financial markets, however, this is one of the most important questions you can ask. A few examples:
Every hedge fund uses some form of risk management to understand the worst case scenario for their portfolio. In general, the larger the firm and more complex the strategy, the more elaborate the analysis.
…click on the above link to read the rest of the article…
