The stock market is ticking higher in the face of continued weak economic news, and it’s mostly due to the good corporate profits we’re getting. For the most part, we’re so far seeing good corporate profits, because expectations were already reduced. Some companies are slightly reducing their outlooks for the rest of this year, but the declining visibility is modest. Corporations are being extremely conservative with their forecasts and rightly so. It makes it easier not to disappoint.
Corporate profits are mostly expected to be flat compared to last year. This makes dividend income all the more important. If you look at a number of blue chip, dividend paying stocks in this stock market, you’ll notice that many of them are actually trading right at their 52-week highs. While expectations for corporate profits continue to be very modest, institutional investors keep buying the dividends. It’s the only way to beat the inflation rate and the probability that the stock market will return little, if any, capital gains going forward.
I expect the U.S. economy will toy with a technical recession next year. I also expect that returns from the main stock market averages will be low, but that corporate profits will hold up well. One or two more years of difficulty will set the stage for the next business cycle to begin.
Intel Corporation (NASDAQ/INTC) slightly beat the Street for the second quarter, but revised its third-quarter outlook for corporate profits downward. The company warned that business conditions in the U.S. and particularly Europe are getting worse. This is no surprise, and due to its fair valuation, this is likely why the stock has been ticking higher since its earnings report. Stability is what this stock market is looking for. International Business Machines Corporation (NYSE/IBM) has also been helpful to the Dow Jones Industrials; its corporate profits beat the street for the second quarter, and the company guided the rest of the year higher. What IBM is doing is squeezing every single penny out of its business. It’s not as if the global economy is really accelerating.
Investor sentiment has been improving over the last few days, and it’s partially due to stable corporate profits so far and the stock market’s ongoing hope for more monetary stimulus from the Federal Reserve. (See “Earnings Season Update: Stock Outperformance on the Horizon.”) Spot oil prices are back over the $90.00 per barrel level, but this isn’t about better investor sentiment; it’s due to tensions in the Middle East.
With the S&P 500 Index around 1,375, the stock market is saying that 2012 corporate profits won’t disappoint in the bottom half. The stock market is holding up extremely well in my view, considering slightly reduced visibility for the rest of this year and increased geopolitical risk. Combined with dividends, a 10% return on the S&P 500 Index isn’t unreasonable this year.