When it comes to earnings growth prospects for the U.S. stock market, there continues to be much discussion about whether the Street’s consensus forecasts for 2011 remain unrealistically rosy. And there’s no shortage of reasons trotted out for raising that skeptical view.
The U.S. economic recovery remains sluggish and unstable. The U.S. government is likely to pull the plug on much of the stimulus spending that fuelled the recovery, and businesses and consumers show little appetite for picking up the slack. Disinflation remains a threat. The widespread inventory rebuild, which contributed greatly to the pickup in business activity earlier this year, is over.
We can throw another log on the growth-doubters’ fire: Pension costs. Underfunding of pension obligations among S&P 500 companies has soared this year – and that’s going to cost them on their bottom lines in 2011. The question is, just how big a cost will it be?
A $380-billion pension bill
In a recent research report, Merrill Lynch chief U.S. equity analyst David Bianco estimated that S&P 500 companies’ total pension funding deficit is $380-billion (U.S.) – up sharply from $264-billion at the end of 2009.
The big increase stems from this year’s historically low interest rates – which directly affect the way companies are obliged to calculate the value of their pension obligations. When rates are lower, the assumptions about future returns must be reduced – and that forces up the costs of meeting current pension obligations, at least on paper.
What Merrill is saying, in general terms, isn’t exactly news to many market watchers; indeed, as Mr. Bianco noted, “The secular decline in rates has been an ongoing headwind for companies with defined-benefit pensions trying to keep these plans fully funded.”
But what Merrill has done is attach numbers to the pension problem – not just in terms of the size of the market’s current underfunding burden, but in terms of what it’s going to mean to profits for the S&P 500 next year.
Another albatross on earnings
Mr. Bianco calculated that the rising pension burden and weak returns in pension plans this year would add up to a $1-a-share drag on S&P 500 earnings in 2011. The hit comes on next year’s earnings rather than this year’s because companies readjust their pension cost estimates at the end of each year and then amortize the revised funding shortfall against subsequent earnings.
It’s worth noting that $1 a share is only a little more than 1 per cent of the current consensus S&P 500 aggregate earnings estimate of $96 a share for next year, based on data compiled by Thomson Reuters Research. If he’s right, that’s considerably less than the 5-per-cent range that some pension watchers had been tossing around earlier this year. Still, it adds to the weight of potential negatives that could keep earnings growth from reaching the Street’s expectations in 2011.