I think the stock market has been able to recover so well from its recent correction low because institutional investors were buying in anticipation of second-quarter earnings season. No doubt, the sovereign debt crisis in the eurozone is able to affect investor sentiment directly in the daily trading action of the stock market; but, because valuations are so reasonable, the downside in the latest correction has been limited.
The uncertainty in global capital markets is really pronounced in the stock market, where one significant down week is followed by a total reversal the next. This is why earnings season can’t come soon enough. The marketplace really needs to hear from corporations and move beyond geopolitical uncertainty to deal with business reality.
Most definitely, the earnings outlook has been reduced for the upcoming quarter and the rest of the year. Yet, just last quarter, most big-cap companies reported that business conditions were improving; they expect business to get better in the bottom half of the year. My view is that what corporations have been saying over the last several quarters is valid. As I’ve written before, management teams have been very cautious in their corporate visibility for the same reasons that individual investors are. In this kind of stock market environment, it pays for a company to be very cautious and then outperform come earnings season. As we’ve seen, the stock market can easily wane after an earnings season is complete. There is, in a sense, a disconnect in my view between what corporations have been reporting and what the stock market has been worried about. Troubles in the eurozone are real, but they are not worthy of a U.S. stock market crash.
Just like this past first-quarter earnings season, stock prices went up in anticipation of the numbers. I view the recent trading action in the stock market as more to do with the same kind of speculation; more so over the news coming from Europe. The geopolitical uncertainty won’t end this year and neither will it end in capital markets. That’s why I really feel that it’s important for stock market investors to keep their holdings domestic. (See Oil Prices Say Zero Growth, While Stock Market Holds up in Current Correction.) No other economic zone (emerging market or not) has better potential for reacceleration than North America.
I’ll be surprised if we don’t get a solid earnings season in the second quarter. Again, not every industry is doing as well as others and you can bet that corporate visibility for the rest of this year will be highly cautious. Yet, there are so many stocks that are doing well in this market and they are not overpriced. Every earnings season is important, but this second quarter earnings season will be responsible for setting the tone for the rest of the year. It is, after all, an election year in many countries and, as we all know, policymakers are gifted at sugarcoating problems for short-term gain. I still predict that the main stock market averages can produce a 10% gain this year, plus dividends, reflecting reasonable valuations and decent earnings growth.