From Wolf Richter at wolfstreet.com:
The magic of Wall Street’s Consensual Hallucination.
The simple fact is that corporate earnings data is out there for everyone to see, but no one wants to see it. Instead, everyone wants to see and believe the sweet fairy tale that Wall Street and Corporate America spin with such skill just for us, because if everyone believes that everyone believes in this fairy tale, even knowing that it is a fairy tale, it will somehow lead to ever higher stock prices.
This is part of a phenomenon we’ve come to call “Consensual Hallucination.”
But that fairy tale got spun to new fanciful extremes in 2015.
Revenues of the S&P 500 companies fell 4.0% in the fourth quarter and 3.6% for the year, according to FactSet, with most of the companies having by now reported their earnings. And these earnings declined 3.4% in Q4, dragging earnings “growth” for the entire year into the negative, so a decline in earnings of 1.1%.
While companies can play with revenues to some extent, it’s more complicated and not nearly as rewarding as “adjusting” their profits. That’s the easiest thing to do in the world. A few keystrokes will do. There are no rules or laws against it, so long as it’s called something like “adjusted earnings.” The rewards are huge, in terms of share prices, stock options, bonuses, and for Wall Street, fees. The ultimate target of the magic is earnings per share. EPS is the most crucial term in the canon of the markets.
Turns out, the 2015 “growth” in earnings, and particularly the “growth” in EPS – so a decline – as reported by FactSet and others is a figment of the vivid imagination of Wall Street and Corporate America, called “adjusted earnings,” where everything bad has been “adjusted” out of it.
The reason every developed economy uses standardized accounting rules is to give investors a modicum of insight into what is going on in a company, compare these numbers to those of other companies, and make at least not totally ignorant investment decisions.
In the US, these are the generally accepted accounting principles, or GAAP, the most despised acronym of Wall Street and Corporate America. Yet even these principles offer plenty of flexibility for financial statement beautification. We get that.
Yet they’re way too harsh for Wall Street. So companies file the required financial statements under GAAP for everyone to look at, but then they hype their “adjusted” earnings in their communications with investors. And the gap between the two in 2015 was a doozie.
To continue reading: For Stocks, a Reality Too Ugly to Behold?
