Analysts turn bearish over investor concerns

Bloomberg

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The biggest earnings-season rally in the United States since 2002 has pushed 34 percent of the companies in the Standard & Poor’s 500 Index above analysts’ price targets for the next year, raising concerns about the pace of the recovery.

The S&P 500 is within 5 percent of the combined price projections of more than 1,700 securities analysts after gaining 14 percent since Alcoa reported first-quarter results on April 7. Caterpillar, the largest maker of excavators, and Citigroup, the bank rescued by $45 billion in U.S. taxpayer funds, are among 170 companies that trade above their average price estimates, data compiled by Bloomberg show.

So far, analysts have resisted lifting price and earnings targets after the S&P 500 surged 37 percent from a 12-year low in March. The combination of falling profit predictions, rising valuations and higher costs for options that insure against losses are raising investor concerns that the rally may have come too far, too fast.

"To expect this to continue to move onward and upward from here would be unrealistic," said Leo Grohowski, chief investment officer at Bank of New York Mellon Wealth Management. "It would be healthy for the market to take a breather and allow some of the fundamentals to catch up."

With more than a third of the companies in the benchmark index for U.S. stocks overvalued compared with their price targets, the S&P 500’s fair value is 970.21, compared with its 929.23 close on May 8, according to data compiled by Bloomberg.

The S&P 500 rose 5.9 percent last week, erasing this year’s losses, after results from the government’s examination of banks reassured investors and the Labor Department said the pace of job cuts slowed in April. Financial stocks led the measure’s advance, surging 23 percent.

More than 200 companies in the gauge have risen at least 50 percent since this year’s low on March 9. Prices of almost half the companies in the measure are within 5 percent of the fair value target, according to data compiled by Bloomberg.

The S&P 500’s steepest nine-week rally since the 1930s began as the biggest U.S. banks said they were profitable in the first quarter, President Barack Obama outlined $787 billion in spending and tax cuts and the Treasury unveiled plans to finance as much as $1 trillion in purchases of lenders’ distressed assets.

"Estimates suggest there isn’t that much further to run because equities are fairly valued," said Hayes Miller at Baring Asset Management. "Earnings growth for 2009 and 2010 can’t support prices too much higher than where we are today."

S&P 500 companies beating profit forecasts outnumbered those that trailed by 2-to-1. A majority of companies in each of the index’s 10 industries posted results that beat projections, Bloomberg data show.

Caterpillar reported 14 times more per-share profit on April 21 than the consensus estimate. Since then, 15 of 19 analysts cut second-quarter forecasts by about 53 percent and 16 reduced their outlooks for the third quarter by 66 percent. No one covering Caterpillar boosted estimates, Bloomberg data show.

Expecting significant decline
The company’s 30 percent surge since its earnings release has pushed the shares to $39.64, 25 percent higher than the $31.83 analysts on average say the company is worth. Nick Heymann at Sterne Agee & Leach rates Caterpillar a "sell" and expects the stock will fall 39 percent, based on his price target of $24.

"We’re going to have a sudden jamming on the breaks of investors’ enthusiasm for early-cycle stocks when they realize they made a big mistake," he said. "If you’re not properly positioned in your portfolio, you may find that you go through the windshield."

Since Citigroup reported per-share profit that was 48 percent higher than the consensus on April 17, more than 50 percent of the analysts reduced their estimates for the second quarter and half cut their projections for all of 2010, Bloomberg data show.

Shares of the bank surged 35 percent last week, leaving them overvalued by 33 percent, based on the average 12-month price target compiled by Bloomberg. The 17-month bear market hurt the credibility of Wall Street analysts and strategists who remained bullish during the worst year for stocks since the 1930s.

They were slow to recognize a recovery, which may force them to play catch-up as stocks climb, said Richard Bernstein, the former chief investment strategist at Bank of America.

"We’re not real good at forecasting the future," Bernstein said. "I used to tell everyone that the most-watched, least-important thing I do is the target on the S&P." Strategists said the index would rally 11 percent last year, according to data compiled by Bloomberg. It lost 38 percent instead.