Wither Earnings?

Earnings season is just beginning, and low equity volumes and bland price action indicates a lack of interest, or at least conviction. A theme that increasingly interests Macro Man and, judging by his email box, some of the more astute researchers out there, is the seemingly inevitable sharp downgrade of US earnings expectations, which would presumably lead to lower stock prices.

While consensus expectations have been marked lower, they still imply stronger SPX earnings in 2008 than in 2007. How that squares with an inability to procure credit and a nascent shedding of labour is an issue that has frankly eluded Macro Man. What we can observe is that the gap in 12 month trailing earnings and the 12 month forward forecast has widened sharply recently. Now, part of this is the simple mechanical function of the forward "earnings year" shifting from 2007 to 2008...though even smoothing for that suggests a wedge is forming between trailing earnings and the forecast.
Even more remarkably, analysts are forecasting stronger 12 month forward earnings now than they were a year ago. To be sure, the degree of optimism has waned considerably from its peak of a few years ago. But observe that in the last two recessions, y/y forward estimates turned sharply negative, reflecting the substantially lower profit base resulting from the economic downturn. On this metric, there is very substantial room for pessimism to increase and downgrades to emerge.
And if the SPX looks vulnerable to revisions, what about the less-covered small caps? Data is admittedly hard to come by here, and Macro Man is working with the scraps that he can retrieve from Bloomberg. (Any readers with good historical data on Russell trailing and forecast P/Es and who is willing to share, by all means contact Macro Man by email.)

But as the chart below indicates, trailing earnings in the Russell have collapsed over the past couple of quarters, which has pushed the trailing P/E up to nosebleed territory (53.3 according to Bloomberg.) But the earnings estimate data that Macro Man has been able to procure hasn't really budged at all.
If there's room for futures disappointment in the S&P, what should we be expecting for the small caps? Yesterday's survey of US small business confidence plunged to the lowest level in the history of the survey, which goes back to the mid-80's. Hardly a ringing endorsement of the small companies that represent the backbone of the US economy, is it? The large cap/small cap trade that Macro Man tracked in the blog portfolio has taken a step back over the past few weeks, as major indices have taken a breather and nudged higher. If the disappointment which appears to be forthcoming actually does materialize, both the SPX and especially the small caps look vulnerable.