“Following the herd has always been a good way to lose money on Wall Street,” writes Ken Brown in today’s Wall Street Journal.

“Wednesday, with the Dow Jones Industrial Average coming off a 355.45-point drop, there is little doubt that the herd is deeply pessimistic about the possibility of a rebound in corporate profits in the next 18 months. No numbers generate more skepticism than the estimates by big-name strategists that the combined earnings of companies in the Standard & Poor’s 500-stock index will rebound sharply anytime soon.”

” ‘The most contrarian viewpoint there is among the institutional-investor community is the view that earnings will surprise people on the upside,’ says Jason Trennert, an analyst at International Strategy & Investment Group, a market-analysis firm.”

“But given the lousy track record of the herd, it’s worth considering the prospect that a turnaround in corporate profits could be on the offing.”

“Earnings for the companies in the S&P 500 reached $55.12 a share, excluding ‘goodwill’ charges, in 2000, according to Thomson First Call, and then posted their biggest drop ever in 2001, falling to $45.16. This year, analysts expect a slight rebound to $48.81.”

“But it’s the estimates for next year that cause the split. Wall Street strategists who calculate these numbers — and whose track records in recent years have been less than sterling — are now saying earnings in 2003 will jump 12% to $54.75.”

“Many of their customers are dubious. ‘My sense is you have very bifurcated expectations,’ says Steve Galbraith, Morgan Stanley’s chief investment strategist, whose estimate for S&P earnings is $58. ‘Many, if not most, of our largest clients — focusing on the potential hit from options, pensions, war, whatever — see $45 as much more reasonable.’ “

“Indeed, short interest — which tracks investors who borrow stock and sell it, betting the stock’s price will fall — remains high, meaning many investors still believe stocks are weak. And in Merrill Lynch & Co.’s most recent monthly survey of fund managers, respondents said they expect just 7% earnings growth in the next 12 months, down from 10% the month before.”

“These earnings numbers are important because they flow into one of the most-tracked barometers of the market, the price-to-earnings ratio. If investors believe the S&P companies will earn just $45 next year, then the price-to-earnings ratio based on 2003 earnings is a pricey 19.5. But if earnings are $60, the P/E falls to a more historically reasonable 14.6.”

” ‘We think further gains in the stock market will be increasingly dependent on a fundamental gain in earnings,’ Mr. Trennert says.”