The stock market certainly isn’t going up because of stronger expectations for corporate earnings. But I think all the conservative forecasts by corporations will lead to another quarter of mostly outperformance this upcoming earnings season. Companies have consistently been able to generate good earnings, even with lackluster revenue growth. Cost cutting is paying off in terms of solid earnings results, and this is the reason why balance sheets are so strong.
With companies in such a good financial condition, a new upward business cycle should produce a major acceleration in corporate earnings. The key, of course, is jump-starting a new business cycle, and it will be awfully difficult to do this if policymakers aren’t able to address all the issues regarding sovereign debt and the fiscal cliff. Country finances are going to be a major issue next year.
The best thing the stock market has going for it right now is its reasonable valuation. (See “Equities Market Doing Fine—Just Look at the Long-term Charts.”) That gives the stock market a lot of leeway, with all the uncertainty on the horizon. We know the stock market went up recently on the hope of new monetary stimulus from the Federal Reserve. Contributing to positive investor sentiment has been quiet on the eurozone’s sovereign debt crisis, somewhat improved U.S. economic news and a weaker U.S. dollar. Whether this lasts is all up to the Federal Reserve.
There really isn’t anything more the central bank can do to stimulate the U.S. economy. Further action from the Federal Reserve will only be to appease Wall Street investors. If the central bank disappoints the stock market with no new action, I think any selloff will quickly be tempered.
The third quarter will soon be over, bringing about a new earnings season. We have the presidential election after that and then another earnings season, which is currently expected to be pretty good. All in all, 2012 should be a good year for the stock market.
All kinds of companies are currently trading at their 52-week highs, and that’s with second-quarter earnings that weren’t robust. If you pull up quotes on a dozen large-cap, brand-name companies, you’ll notice that price-to-earnings ratios are reasonable.
Ever since the subprime mortgage-induced stock market crash in 2008, corporations have been very reticent to invest in new facilities, equipment, and employees. This is why cash balances are so large. With strong cost control, earnings have held up extremely well. Slowly, corporations are beginning to open up their wallets; we see this in the technology sector, where big companies are investing in information technology (IT). Because of all the uncertainty, corporations have been very conservative with their earnings forecasts. My prediction is that the upcoming third-quarter earnings season will surprise to the upside.