Why the Bears Are Smiling

At around 1191, the S&P trades at just over 18 times Wall Street's consensus estimates for corporate earnings in 2005. That sounds cheap to traders who haven't shaken their nostalgia for the tech bubble. Back in the 1990s, the S&P soared over 28 times GAAP earnings on lower profits. Now, prices have come way down and profits have roared back, so buying stocks looks like a no-brainer.

However, compared with the S&P's average price-to-earnings ratio since 1935 of 15.7, stocks look a bit more pricey.

"Investors are conservative now compared to five years ago, but when you look back further in history, that's not necessarily the case," said Standard & Poor's market equity analyst Howard Silverblatt.

Meanwhile, economic growth appears to be on the wane. The government reported last week that GDP grew 3.8% in the first quarter, down from its annual growth rate of 4.4% in 2004. Furthermore, although corporate profits remain strong by historical standards, their growth is also slowing.

Wall Street analysts expect year-over-year growth in corporate profits for the S&P 500 to slow to 11.9% in 2005, down from 20.2% in 2004, according to consensus estimates reported by Thomson First Call. While the second quarter is expected to see the slowest growth of the year, at 7.3%, bulls have pinned their hopes on a stronger second half. Analysts expect profits to add 15.1% in the third quarter, down from last year's pace of 16.8%. For the fourth quarter, they're projecting growth of 12.2%, down from last year's 19.7%.

"We're getting negative surprises every day," said Tom McManus, an equity strategist with Banc of America. "An increasing number of companies are finding it difficult to meet expectations. At these valuations, positive surprises are not a big surprise, but negative surprises are big. I think the odds of any given company reporting a disappointing number have risen."