Markets

U.S. market is 'smoking dope on earnings' and investors are likely to be disappointed, economist says

Key Points
  • Investors should stay bearish on U.S. stocks, according to TS Lombard.
  • The research firm believes a rebound in U.S. stocks is premature.
  • The economic recovery from the dire Q1-Q2 recession will be gradual, the firm said.
Adam Jeffery | CNBC

Investors should stay bearish on U.S. stocks until the full extent of the economic damage caused by the coronavirus pandemic is known, according to TS Lombard, which warned that investors were over-estimating a quick recovery in U.S. corporate earnings.

Charles Dumas, chief economist at the economic research firm, told CNBC Tuesday that "the market is essentially trading off a view about 2021 that is not going to happen."

"The basic point here is that in 2021 the market estimates of S&P earnings are not merely up from 2019 but they're right back on the long-term growth trend, which is highly improbable. On our forecast, the relationship of the economy to earnings produces a 2021 number that is down probably around 20% from the 2019 level," he said.

"Essentially what we're saying is that the market is smoking dope on earnings, for one. And for two, it's (trading) at a P/E (price to earnings) ratio that even in relation to its own optimistic view about earnings, takes you right back to the 1999-2000 peak of tech bubble."

P/E ratios — often closely watched by investors — are the current share price of a stock divided by its earnings per share.

Dumas was expanding on a TS Lombard report from mid-June, in which he warned of a "major disappointment" of investor hopes for a rebound of earnings next year. 

"In our forecasts this is a direct result of the economic recovery from the dire Q1-Q2 (first quarter-second quarter) recession being only gradual – a view that is widely shared by economic forecasters, including the Fed, but ignored by investors," Dumas and his team wrote.

U.S. stock market performance appears to have become disconnected from the economy throughout the pandemic, with hopes that fresh money could be injected into economies (as the U.K. government announced Tuesday, for instance) seemingly buoying sentiment. The S&P index has risen almost 32% since hitting a low for the year on March 23.

The dislocation between market sentiment and news flow was no more evident than Monday when the Dow climbed 580 points, and the S&P 500 also gained, climbing 1.5%, despite a backdrop of rising coronavirus cases in the U.S. as states reopen, prompting some governors to walk back or delay plans to relax lockdown restrictions.

TS Lombard's Dumas, who claims to have forewarned of the 2008-2009 financial crash, said the current level of stock valuations were not justified by the reality of the situation — a global pandemic in which more than 10.3 million people have been infected and over 505,000 people have died, according to Johns Hopkins University.

"For the current level of prices to be justified, you'd have to have an extreme upside scenario turning out in terms of the medical aspects of this whole thing," like a vaccine that could be disseminated this year, he said, "and we simply don't expect that."

"Essentially, the market is presuming something along those lines. Without that, the earnings are going to be a disappointment and the market will come back down to earth," Dumas added.

These are the three types of investors in extremely volatile markets
VIDEO2:5602:56
The three types of investors in extremely volatile markets