Should You Run From This Stock Market?

Should You Run From This Stock MarketIt’s pretty difficult to have a rising stock market when corporate earnings aren’t growing. This summer, the main stock market averages all produced solid gains on the back of flat earnings, based on the expectation of a third round of quantitative easing (QE3). Now that the Federal Reserve has once again done what Wall Street wanted, we’re left with the reality of a global economy that isn’t able to produce a meaningful amount of earnings growth.

We’re seeing this in recent corporate earnings warnings, and in my mind, there are only two things keeping the stock market currently afloat: the relative certainty of future dividend payments and the continuing leadership of select technology stocks. Certainly, the stock market’s fair valuation is a factor in keeping sentiment solid. According to Bloomberg, the S&P 500 Index is currently trading 14.9 times reported corporate earnings and 14.1 times estimated earnings. This is about 14% below the five-decade average for the S&P 500.

Corporate earnings estimates have been moving up for the fourth quarter this fiscal year, and we know that corporations have excellent balance sheets. My best guess in this upcoming third-quarter earnings season is that the financial sector will post great numbers. In the second quarter, the big banks and investment firms reported surprisingly good corporate earnings; but, as we know, the stock and bond markets have been buoyant for most of the third quarter. The technology sector is the stock market’s leader this year, but the financial sector will be the stock market’s surprise.

This is not a stock market you should run from or take profits. The stock market is due for a correction only because of its sustained run over the last couple of months. I view the stock market as being exactly where it should be, given the current corporate earnings picture. Now that some corporate earnings estimates are going up, there is a case for arguing that share prices will rise going into 2013.

Excluding a new war or some other major shock, Wall Street now expects S&P 500 companies to produce 12% annual earnings growth through to 2014. That’s pretty darned good in a slow-growth environment. There is some momentum to current economic news (especially in the housing market), and that’s all that this stock market needs for further advancement.

The weakened outlook for Caterpillar Inc. (NYSE/CAT) is definitely not unexpected, with China slowing and mining investment taking a break.

Caterpillar Chart

Chart courtesy of

We’ve had other meaningful earnings warnings from Intel Corporation (NASDAQ/INTC) and FedEx Corporation (NYSE/FDX); but on balance, there haven’t been too many surprises as the third quarter comes to a close. (See “Will the Stock Market Tank on Earnings Warnings?”) I’d like to see more technical confirmation from the Dow Jones Transportation Index, which has been a real laggard. It’s possible that the earnings picture with these companies will improve in the fourth quarter due to oil prices. Regardless, this isn’t a stock market to be running from.