How Easy Money Is Hiding the Real Problems in Corporate America

stock marketThe stock market surged on Monday, but it wasn’t due to the report of any major positive economic data.

The S&P 500 surged on news that stimulus-friendly Fed Vice Chairman Janet Yellen may become the next leader of the Federal Reserve after front-runner Lawrence Summers announced his withdrawal. The boost to the stock market was due to the assumption that Summers was a supporter of tapering and less monetary stimulus.

Yet while the upward move was welcomed by Wall Street, it’s not what the U.S. economy needs. What the stock market and America really need are stronger economic numbers that support the rise in the stock market.

We need to see the jobs market picking up instead of losing steam, as was the case in August. After spending trillions of dollars on stimulus, we still need more growth in the economy.

Also, with the third quarter coming to an end in a few weeks, we need to see a boost in earnings in corporate America as a result of revenue growth, not because of aggressive cost-cutting and income manipulation. Revenues are estimated to grow 2.6% in the third quarter, according to FactSet. (Source: “Earnings Insight,” FactSet Research Systems Inc., September 13, 2013.) The estimate has already been revised downward from the three percent in June, so I’m skeptical.

If the economy was truly healthy, we should be seeing consistent jobs growth, better manufacturing data, higher consumer spending, and rising corporate revenues.

These are the reasons why the stock market should advance higher, and not simply because the easy money is allowed to flow unabated into the economy. When this happens, it opens up the stock market to potential issues and selling down the road.

According to FactSet, earnings growth for the S&P 500 in the third-quarter earnings season is estimated at 3.5%, with the financials leading the way and healthcare trailing the group.

But as of September 13, about 88 S&P 500 companies have issued negative guidance for the third quarter, versus a mere 18 issuing positive guidance. The negative guidance representing 83% of the companies that have issued guidance is well above the five-year average of 62%. In my view, this implies corporate America is shakier now than in the past few years.

The stock market should advance based on solid fundamentals with reference to the economy and the companies. The problem over the last few years is that many poorly performing companies moved higher only because of the overall momentum of the broader stock market. Without the support of solid fundamentals, these companies could easily plummet on the charts. (Learn how to protect your investments from the Fed-induced stock market in “Worried the Market Will Crash, but Don’t Want to Sell Your Stocks? Buy This Insurance Policy.”)

With the third-quarter earnings season set to begin in a few weeks, it will be important to see if revenues are growing to drive earnings. If this is the case, then I would be more bullish.