It's Earnings Season: What Is Stock Market Looking At?

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by: John M. Mason
Summary

Concern is now being expressed over the results expected to be reported by the corporate world this earnings season, even the possibility that there will be an earnings recession.

Care should be taken in making this judgement because last year's profit results were significantly impacted by the December 2017 tax cuts and how they were financially engineered.

Furthermore, during the past ten years, the stock market has been closely focused on what Federal Reserve monetary policy is, and this will not change, at least in the near-term.

For the past ten years or so, I have argued that investors in the stock market have placed most of their attention on the behavior of the Federal Reserve System.

For much of this time Federal Reserve officials led by Chairman Ben Bernanke overtly focused on the stock market with the intention of creating a wealth effect in the economy that would stimulate consumption expenditures, and, in doing so, would stimulate the economic recovery from the Great Recession.

As the economic recovery progressed, the Fed, although it moved to raise its policy rate of interest and to reduce the size of its securities portfolio, assured market participants that it would err on the side of monetary ease in the case it appeared as if the stock market might be weakening.

So far, in my opinion, the Federal Reserve continues to stand ready to provide this downside protection to the markets.

Michel Wursthorn, writing in the Wall Street Journal argues that even though there is an expectation that corporate profits may not be so robust in 2019,

“So far, investors appear to have been looking past the expected profit crunch thanks to a more accommodative Federal Reserve.”

As a consequence, the S&P 500 stock index is up more than 15 percent since January. This is the best beginning to a year since 1998. This index is now “within striking distance” of the historic high it reached in late September 2018.

That run-up has put it within striking distance of the high it reached last September, just before markets were routed as the year ended

Mr. Wursthorn includes the quote “Everything always starts with the Fed…” in his article.

It appears that several “technical factors” are also, currently supporting the call for higher stock prices.

This, of course, doesn’t mean that we should not pay attention to the other information swirling around the Internet, newspapers, and TV news programs.

Mr. Wursthorn presents us with some pretty dire news:

“Analysts estimate S&P 500 profits in the first quarter contracted 4.2% from a year earlier, according to FactSet. They expect that will be followed by no growth in the second quarter.”

“That puts the broad index at risk of entering its first earnings recession—marked by at least two or more consecutive quarters of declining earnings—since 2016.”

One reason for this decline is that profits experienced a “short-term high” last year as many corporations benefitted from the tax cuts passed by the US Congress in December 2017. This “high” makes year-over-year comparisons hard, especially since much of the provisions of the tax cuts got tangled up in the sophisticated financial engineering practiced by many of the major corporations within the S&P index.

FactSet reports that S&P 500 companies grew profits 20% in 2018, one of the best growth rates since the financial crisis. How much of this is real is up to question.

Mr. Wursthorn reports “Analysts see profits growing just 3.7% this year.”

An interesting coincidence is that Robert Shiller’s measure of the Cyclically Adjusted Price Earnings ratio, CAPE, hit a near-term peak in September 2018, the same month the S&P 500 index reached it’s current historic high.

Event though Shiller’s CAPE measure “smooth’s” out cyclical data, it is interesting that this near-term peak of 32.62 for the CAPE coincided with the historic high of the market, but also with the surge in corporate profits coming from the tax cut benefits.

If corporate profits do fall into an “earnings recession” this year, the CAPE will rise back toward it’s near-term high from it’s current level of 31.08.

As far as a technical indicator, the CAPE measure moving back up to last September’s high would mean the stock market was highly overvalued.

And, still there are other areas of concern, one of them being the slowdown in global economic growth but this list also includes the Brexit fiasco, the tariff wars, and other political uncertainties now crowding in on the horizon.

Right now, I side with the quote presented us by Mr. Wursthorn, “Everything always starts with the Fed…”

I believe that over the past ten years, the stock market has become so attached to the monetary stance of the Federal Reserve that what the Fed does will dominate what happens to the S&P 500 index. If the Fed appears to waver in its promise to err on the side of monetary ease in order to keep the stock market then we could be in trouble.

I believe, however, as I have recently written, the Fed will not abandon this stance.

The problem the Fed now faces is the “noise” that is now coming from the White House. Political interference, will not, at this time, gain anything in the way of faster economic growth or lower unemployment, and will only make the job of Federal Reserve officials harder. I am saying this before the two new potential members of the Board of Governors, now being considered, represent a whole new, different case. We can only deal with that once these individuals join the Board.

For now, the near-term future of the stock market seems to rest on the belief of what the Federal Reserve is doing… and will do.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.