Is the Bull Market Sustainable? The Proof Will Be in the 2Q09 Pudding

As dramatic as Tuesday's market decline was, there are several reasons to conclude that a market that was clearly fully valued (see last week’s postings) was one that was susceptible to any signs of economic and/or political areas of concern.

On the economic side of the equation was last week’s negative reading in my Macro Economic Consensus Trend indicator (see accompanying table and description below). After many weeks of net positive readings, last week’s negative -3 net contributed to taking some of the positive froth out of the fully valued market.

As for the political dynamic, more than a few areas of concern – Iranian election results, the loose screw in North Korea, and the US President and media Star in Chief with his major government initiative du jour – was more than the market could bear.

However, as important as all these factors are, it does appear that the more significant event that will determine sustainability of the cyclical bull market will be the earnings reports, which begin next month. For 2Q09 earnings will provide the most direct sign that the above consensus economic data generated over these past months (noted above) has interpreted into higher corporate profitability. And it is higher profits that will be needed to justify the expected 1050 for the S&P 500 that current market levels imply.

Investment Strategy Implications

Investors can hoop and holler, wish and hope, and stocks can surge and plunge, but the proof will be in the 2Q09 pudding as to whether the anticipation of economic stabilization and higher corporate profits imbedded in a fully valued market come to pass in the form of higher stock prices. Until then, marking time is the more likely outcome.

*Earnings (cash flows) are one of the key fundamental-analysis inputs upon which valuation (and therefore investment) decisions are made. The fundamental premise for the above analysis is that current earnings expectations incorporate the consensus view. Therefore, whenever macro economic reports come in above or below consensus expectations, earnings forecasts will adjust accordingly – with a lag. As economists change their outlook, the individual company analysts, taking their economists’ changed outlook, will follow suit and change their forecasts accordingly. By monitoring the data in real time, an investor can gain a competitive advantage by anticipating changes to earnings forecasts as the above or below consensus reports are filtered into the forecasts.

Comments

[Larry House:]

Yes, it is a time of great uncertainty. There does not appear to be any reason to be in a hurry to get in the market. Almost certainly there are better entry points to come--even if the overall trend is up--which I doubt.

Jun 17 04:37 PM

[Mistrofan:]

Vinny - I like your article and your style. But I would rather argue that someone has to be forward looking rather then what happend in Q2.

Jun 17 06:29 PM

[bartpr:]

you are ignoring the history of market recoveries in major bear slides.
all slides greater than 45% had recoveries of 60% of the fall within 250 trading days. i do not believe we will recover to the highs in any reasonable time frame, though. will be gone by the 250 time days.

Jun 17 08:40 PM

[cameroni:]

Don't let 2nd quarter results persuade you that everything is going to be OK. There is no earnings consensus to describe the future now. Far from it. From past history we already know that publicly traded companies will do everything in their power as sales fall to boost earnings to protect share values and maintain their borrowing power.

Look deeper into their balance sheets and income statements, look for consolidation of their core business, property sell-offs, layoffs or firing of staff. Look for asset sales that boost the bottom line "one time only". Do not let your heart betray your mind. These Q2 results will almost all be deceptive to a man so take it with a big grain of salt.

The real proof in the pudding will start to come Q4 when some of the manipulative revenue boosting shenanigans have mostly been exhausted. I think it is very important to judge good companies now on core earnings growth in the absence of unusual "one time" changes or the disgorging of valuable properties that you knew would have contributed to better base-line earnings had they been retained.

These fat sales are normally only made to support weakened companies and cannot be repeated. Look to the fundamentals.


On June 17 2009 the Author wrote:

"Earnings (cash flows) are one of the key fundamental-analysis inputs upon which valuation (and therefore investment) decisions are made. The fundamental premise for the above analysis is that current earnings expectations incorporate the consensus view".

Jun 17 10:12 PM

[cameroni:]

Don't let 2nd quarter results persuade you that everything is going to be OK. There is no earnings consensus to describe the future now. Far from it. From past history we already know that publicly traded companies will do everything in their power as sales fall to boost earnings to protect share values and maintain their borrowing power.

Look deeper into their balance sheets and income statements, look for consolidation of their core business, property sell-offs, layoffs or firing of staff. Look for asset sales that boost the bottom line "one time only". Do not let your heart betray your mind. These Q2 results will almost all be deceptive to a man so take it with a big grain of salt.

The real proof in the pudding will start to come Q4 when some of the manipulative revenue boosting shenanigans have mostly been exhausted. I think it is very important to judge good companies now on core earnings growth in the absence of unusual "one time" changes or the disgorging of valuable properties that you knew would have contributed to better base-line earnings had they been retained.

These fat sales are normally only made to support weakened companies and cannot be repeated. Look to the fundamentals.


On June 17 2009 the Author wrote:

"Earnings (cash flows) are one of the key fundamental-analysis inputs upon which valuation (and therefore investment) decisions are made. The fundamental premise for the above analysis is that current earnings expectations incorporate the consensus view".

Jun 17 10:12 PM

[Old Trader:]

I'm thinking the next round of earnings report will be less likely to be "good" or "better than expected", given that most of last quarter's beats were the result of cost cutting amidst revenues being down sharply. That only works for so long. The run up in commodity prices since then will add additional pressure on margins.

Jun 18 09:32 AM