Don't Get Duped by Gamed Corporate Earnings

Did you know the stock market's recent pullback of 5% is now the largest since the November lows? The pullback, thus far, has been orderly, so is this just another buy-the-dips opportunity?

I like to attack the markets with a four pronged approach.

Fundamentals, technicals, sentiment, and most importantly, common sense, should all be involved in the investment decision. I will take a look at these other 'prongs" we use at ETFguide.com in the near future, but for now questions surrounding the fundamentals (NYSEARCA:SPY) should be front and center.

This article focuses on the current "games" that are being played by Wall Street to (once again) dupe the public into buying stocks.

The All-Important Earnings

Stock prices (NYSEARCA:VTI) are rising, but not because of improving earnings. And, big surprise Wall Street is trying to hide this from you. Let me explain how.

For only the third time since the 1980's, price multiples (NYSEARCA:DIA) are growing over 30x faster than earnings. The table I created below was first published May 20, two days before the recent market top. In my article "Which Market is Correct" I showed the details of the last five quarters and the recent growth in stock prices (NYSEARCA:IWM) in the face of stagnant earnings.

This table is a big clue that earnings are not living up to expectations, and a bigger reason I decided to dive deeper into the earnings analysis.

This in and of itself should be concerning, but the real issue is that while P/E ratios are coming in at 16.5x, Wall Street is trying to misdirect you to focus on their 2014 (and even 2015) earnings estimates instead of the real world's earnings that are actually occurring.

Earnings "Games"

Most of the earnings Wall Street speaks of are based on "expected" future earnings, meaning they haven't happened yet. Even worse, they now are using their 2014 or even 2015 "expected" earnings as their focal point, already forgetting about 2013.

Why? because actual earnings aren't living up to expectations.The chart below provided by FactSet shows how earnings estimates have "come down" significantly in 2012 and 2013 from their initial announcements, but this is no new phenomena.

Wall Street used an "expected" 2013 earnings estimate of $118 in early 2012 in order to trick investors into buying an expected "low P/E" of 13x, just as they are now using an "expected 2014 P/E of $123 today to justify a low "expected" P/E of only 13.3x to the public.

That expected P/E of 13x used in 2012 turned out in reality to be a P/E of 15x+ as earnings came in at only $97/share, and the 2014 P/E is likely to follow in similar footsteps.

Make no mistake as the chart shows in 2006, 2007, and 2008, expected earnings also were expected to continue to grow higher into perpetuity, and we saw how that turned out. Do you still trust the experts in estimating future earnings?

The chart reveals how Wall Street time and again greatly exaggerates estimates at the beginning of the reporting period and then ratchets the estimates down just as they shift their (and your) focus to the next year in order to cover their tracks.

This strategy works for a few years, but as we saw in 2000 and again in 2007, it will not work indefinitely. Wall Street can manipulate the projected earnings all they want, but thank goodness they haven't found a way to manipulate real earnings.

Earnings are cyclical in nature and may have already started to peak out. If so, then P/E ratios are likely too lofty to justify prices (NYSEARCA:SH) at these levels. Other ETFs that can be used by aggressive traders to take advantage of a deteriorating market are the ProShares Ultra Short (NYSEARCA:SDS) and the ProShares UltraPro Short (NYSEARCA:SPXU).

The ETF Profit Strategy Newsletter focuses on fundamentals, technicals, sentiment, and common sense to stay ahead of the markets.