Why the Risks So Outweigh the Reward in Today’s Stock Market

The chart below of the Dow Jones Industrial Average depicts the precise moment when the Federal Reserve made its announcement last Wednesday that it was not planning to taper its quantitative easing at this time.

Dow Jones Industrial Average Chart

Chart courtesy of www.StockCharts.com

This is really troublesome. Key stock indices have become addicted to easy money and any news about more money printing just drives the market higher. This pattern has been going on since the Federal Reserve first promised it would rev up its printing presses back in 2008.

Unfortunately, as this continues, the fundamentals that are supposed to actually drive key stock indices higher—corporate earnings—are under major pressure. We have been seeing companies in key stock indices playing “tricks” to increase their corporate earnings per share (such as buying back their own stock), but these antics can’t go on forever.

Software giant Microsoft Corporation (NASDAQ/MSFT) has announced the company’s board of directors has approved a share buyback program worth $40.0 billion. (Source: Microsoft Corporation Investor Relations, September 17, 2013.)

CBS Corporation (NYSE/CBS) said it has increased the amount of its share buyback program to $6.0 billion. (Source: CBS Corporation Investor Relations, July 25, 2013.)

These two companies are only two of the many big-name companies in key stock indices that are rigorously buying back their shares. Other names, like Juniper Networks, Inc. (NYSE/JNPR) and Time Warner Cable Inc. (NYSE/TWC), are taking a similar approach.

As I have recently written, it’s not just corporate earnings growth that’s the problem—revenue growth is also lacking. Companies in key stock indices enjoyed double-digit (or close to it) earnings growth in 2009, 2010, and 2011, as they recovered from the recession and the credit crisis. But today, take away the stock buyback programs and cost-cutting, and these companies are barely growing earnings or revenues.

As this disparity continues—key stock indices climb higher and corporate earnings growth becomes tricky to achieve—the risk for the stock market only rises. The market knows companies can’t deliver on earnings and revenue growth, hence the dependence on money printing now to drive key stock indices higher. How sad.

When and if the Federal Reserve finally starts to pull back on the quantitative easing, it won’t be a pretty sight.

I remain skeptical of the stock market rally we’ve been experiencing this year—its determination has surprised me. Irrationality takes over sometimes in the stock market and this may just be one of those moments. What I do know is that when reality finally does kick in, and it will, the risk to be in the market will not have been worth it.

What He Said:

“There is no mixed signal about this: Foreclosures in the U.S. will continue to rise, the real estate market will get weaker, and the U.S. economy will get weaker. Smart investors should seriously consider unloading their stocks of consumer-products companies that produce nonessential goods.” Michael Lombardi in Profit Confidential, March 12, 2007. According to the Dow Jones Retail Index, retail stocks fell 42% from the spring of 2007 through November 2008.