Stock Prices and Corporate Profits:
The Divergence Explained

So far this month, 31 major companies have filed with the U.S. Securities and Exchange Commission to go public, the highest number since the summer of 2007. Corporate earnings? They’re booming again, too. But why are the stocks for many of the most profitable companies selling so far below their five-year highs? Michael explains.The good old times must be back.

So far this month, 31 major companies have filed with the U.S. Securities and Exchange Commission to go public, the highest number since the summer of 2007.

Corporate earnings? They’re booming again, too. Just look at some of these first-quarter earnings reports:

Ford Motor Company (NYSE/F), the second largest U.S. car maker, made $2.55 billion. Johnson & Johnson (NYSE/JNJ) made $3.48 billion. The Goldman Sachs Group, Inc. (NYSE/GS), fifth largest U.S. bank, posted a $2.74-billion profit. Wells Fargo & Company (NYSE/WFC) posted a $3.76-billion profit. JPMorgan Chase & Co. (NYSE/JPM) made a $5.56-billion profit.

Five companies; $18.0 billion in first-quarter profit.

Why did I choose these five? Because all of them reported earnings substantially higher than in the same period of 2010! Corporate profits are back big-time and this is adding fuel to the bear market rally in stocks that investors have been so enjoying for 26 months now.

But when we look closer at the five companies I list above, all five, except for Ford Motor Co., have their stocks selling substantially below their five-year highs.

The stock market is a leading indicator, not a lagging indicator. By pricing the stocks on my list above, except for Ford, well below their five-year price high, the stock market is telling us that it does not believe that the better-than-expected earnings reports will continue.

As for Ford, the company’s stock is trading close to its highest level in 10 years. As we all remember, this is the only major car company that did not get a bailout from Washington during the credit crisis.

Michael’s Personal Notes:

Gold investors are noticing that, while gold bullion is rallying to new record highs ($1,509 per ounce as I write this morning), the gold stocks are lagging the rally in gold bullion. Why is this?

In my 10-year involvement in this gold bull market, I’ve often noticed that either gold stocks or gold bullion lead the bull, but rarely both. We are in one of those periods where gold bullion is breaking to new price highs and the gold stocks are failing to follow…it’s almost like the gold stocks do not believe that gold prices are moving so high!

I believe that gold stocks are forming a strong base from which to make their next advance. There’s no escaping it…higher gold bullion prices lead to higher profits for gold mining companies. Just this morning, Barrick Gold Corporation (NYSE/ABX), the world’s largest gold-producing company, reported that it made a $1.0-billion profit in the first quarter of 2011, up 22% from the same period of 2010.

There are many good buys in the junior and senior gold stock sector right now.

Where the Market Stands; Where it’s Headed:

The Dow Jones Industrial Average has climbed 1,038 points so far this year, up 8.9% for 2011. The S&P 500 opens this morning at its highest level since June of 2008.

I’ve been calling it a bear market rally since March of 2009 and all I can say is that this bear has failed to disappoint. As I have been saying for over two years…technically, you do not trade against the trend, which has been upward. And, fundamentally, you do not “fight the Fed.” We are living in the most accommodative monetary policy period in history. Short-term interest rates are near zero. The Federal Reserve is taking actions we’ve never seen before.

Add to all this a strong corporate earnings quarter and, bang, the rally marches on. But there are cracks in the lining, my dear reader. Long-term interest rates are rising, the U.S. dollar is under immense pressure to devalue, inflation is becoming a problem, and memories of the worst recession since the Great Depression are fading fast.

Enjoy the profits from this bear market rally while they last, because they will not last much longer. Upside profit potential in stocks (five percent to 10% higher) does not outweigh the risks.

What He Said:

“Overbuilt, over-speculated, over-financed and overdone. This is the Florida real estate market right now. For those looking to buy for personal use or investment, hold off! The best deals are yet to come. I continue with my prediction that the hard landing in the U.S. housing market, which is now affecting lenders, will have significant negative effects on the U.S. economy.” Michael Lombardi in PROFIT CONFIDENTIAL, April 3, 2007. Michael started talking about and predicting the financial catastrophe we started experiencing in 2008 long before anyone else.