Here’s Why the S&P 500 Keeps Rising, Despite Steadily Lower Earnings

questionBrad Hoppmann: When it comes to the direction of the stock market, “Nobody ever said it had to make sense.”

That’s the profound observation of David Rosenberg, Chief Economist & Strategist at Gluskin Sheff.

In a note to clients on Tuesday, the respected market-watcher attempted to explain the seemingly incongruent nature of a market where stock prices are going up … even as earnings are deteriorating.

As quoted in a feature piece on Yahoo! Finance this morning, Rosenberg said:

“With two-thirds of the S&P 500 having reported [Q2 financial results], earnings are on track for a 2.8% year-over-year decline on a still-soft -0.1% revenue stream …  This all may be sequential improvement — as in, less negative — but is still contraction nonetheless for five quarters running.”

Given what so many have accurately pointed out is objectively an earnings recession, you would think that stocks would be trading poorly.

Yet U.S. stocks in the aggregate are trading near their all-time high.

Yes, it’s time for investors to realize that we have to stop making sense.

 

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Perhaps the best way to observe this nonsensical disconnect between slowing earnings and rising stock prices is to take a look at the following chart, as it appeared in the Yahoo! Finance story.

 

Here the red arrows represent the rising trend in stock prices on the S&P 500 since late 2014 (green line), and the downtrend in trailing 12-month EPS (blue line) on the index over the same period.

Here’s how Rosenberg describes the unusual situation:

“Yet, since the earnings recession began, the stock market managed to look right through it and rally more than 20%… Go figure.”

Here’s one reason why the current situation in markets doesn’t make sense. Traditionally, we are all taught that earnings growth (and expected future earnings growth) is among the most-important historic drivers of equity prices.

As explained in the Yahoo! piece:

Much has been written about the stock [market] based on hundreds of years of observations. And in all of those volumes, we walk away with a couple of things: 1) stock prices are arguably based on some theoretical value derived from future earnings; 2) it’s very hard to calculate that theoretical value; and 3) stocks rarely trade at or near any theoretical value.

To be a bit more specific: 1) stock prices have a relationship to earnings; 2) that relationship is complicated; and 3) that relationship rarely holds.

It’s true that the earnings/equity price relationship isn’t making traditional sense right now. But over the long run, companies with outstanding earnings metrics have proven to outpace the market — given a long enough time line.

Yet while that may make intuitive sense, it’s definitely understandable that the current situation has stopped making sense.

So, if earnings growth is grinding lower while stock prices are rising, then there must be something else at work to explain the rising market.

Fortunately, we do know what that something else is …

It’s called central banks.

In fact, that same chart of equity prices vs. EPS shows that both surged in early 2009. Right when the Fed embarked on its unprecedented quantitative easing spending spree.

The easy monetary policy (in the U.S. and around the world) pushed capital into risk assets such as equities. This has caused a seven-year bull market — or, dare I say it, “bubble” — ever since.

Now the market seems to be running on the sugar high of easy monetary policy … even without earnings growth.

How long can this last? Well, probably a little while longer, as most trends last longer than expectations.

However, when the sugar runs out, and the earnings growth leaves the party — look out below.

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What do you think of this market in light of the current earnings and price trends? Has everything stopped making sense, and does that worry you as much as it worries me? Let me know by leaving a comment on our website or by sending an e-mail.

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The Dow broke its seven-day losing streak as oil climbed back above the psychologically important $40 mark. The Industrials inched higher by 0.2%.

  • A moment in tech history. The five largest companies by market cap are all technology firms — Apple (AAPL), Alphabet (GOOGL), Microsoft (MSFT), Amazon (AMZN) and Facebook (FB). This data, valid as of Monday’s closing bell, is based on the companies’ market caps.
  • Bankruptcies on the rise. U.S. businesses are filing Chapter 11 at a faster rate than in 2015, rising 25% year-over-year. Meanwhile public companybankruptcy filings rose 46% in 2015, which BankruptcyData.com attributes in large part to the energy sector.
  • Oil gains 3.3%. Analysts expected today’s EIA report to show that U.S. crude inventories fell 1.4 million barrels. Instead, they rose by that much. But that news was offset by an unexpected draw in gasoline supplies, which fell by 3.3 million barrels vs. 200,000 expected. Refiners caught a bounce, including Marathon Petroleum (MPC), which gained 6.3%.
  • Hurricane Earl. The National Hurricane Center has upgraded the tropical storm brewing in the Caribbean to hurricane status Wednesday. Earl could make landfall in Belize as soon as this evening. A hurricane warning is also in effect for parts of Honduras and Mexico. We know we have many world travelers who read this newsletter. Please stay safe!

The iShares S&P 500 Index (ETF) (NYSE:IVV) rose $0.64 (+0.30%) to $217.47 per share on Wednesday. The IVV has gained 6.15% year-to-date.

IVV-2016-08-03

This article is brought to you courtesy of Uncommon Wisdom Daily.

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