Stock Market Reality: Good Corporate Earnings Just Aren’t Enough

Stock Market Reality: Good Corporate Earnings Just Aren’t EnoughOne thing really bothers me about the trading action in the stock market so far this year. While there is positive anticipation regarding corporate earnings, the stock market seems to be selling off on positive, non-corporate news and this is worrisome. Investor sentiment has improved from the fourth quarter last year, but it’s still not strong enough to foster any sustainable upward price trend at this time. Companies are forecasting good corporate earnings, but the marketplace just isn’t interested. “Fragile” is the word that I think best describes the state of the stock market right now.

Last year, corporate earnings were very good, especially considering the minimal GDP growth experienced in the U.S. economy. But the marketplace was more focused on the uncertainty created by Europe’s sovereign debt problems. Weak investor sentiment usurped the reality of good corporate earnings and strengthening balance sheets. This is why I wouldn’t be surprised at all if the stock market performed similarly to last year—a decent start, followed by consolidation, and then correction. Corporate earnings will be solid in 2012, but no one wants to buy them.

Individual investor participation in equities has been declining for years. This is no surprise considering the stock market hasn’t appreciated for over a decade. The hottest asset class in the last 10 years was mostly real estate, and then its collapse was met by significant price strength in commodities. It’s as if the general marketplace ignored corporate earnings and, accordingly, the stock market did nothing. (See How Stocks Are Reflecting the Structural Excesses of the World.)

I’ve been a student of the equity market my entire adult life and I can tell you that I’m not very enthusiastic about the prospects for the stock market over the next few years. Corporate earnings should continue to hold up well, but the marketplace just isn’t interested. There are too many underlying problems (mostly related to debt) in the global economy and I think it’s fair to conclude that investors should not expect anything from the broader stock market over the medium term.

Don’t get me wrong; I’m not saying that there aren’t good trades out there (I just discovered a medical device company whose business is booming), only that investors should not expect the broader market to provide any tailwind for their holdings. There are always good trades in the stock market, even in a bear market, but I wouldn’t be a buyer of an index fund.

A lot of change has occurred over the last 15 years. I’ll never forget the exciting trading action in the stock market from 1995 to 2000 during the technology bubble. That was a once-in-a-generation kind of market. Then the real estate market became the next asset class to boom into a bubble and now we’re probably mid-way through a booming commodity price cycle. When I think about what’s next, I remind myself that there aren’t many asset classes left.

I do feel that corporate earnings will continue to be solid, but the broader stock market isn’t the place to be. Further economic recessions are likely in the not-too-distant future and, as financial markets correct, a greater weighting towards commodities should pay off better.