Stock Market’s Rise; Is It Powered by Hot Air?

Stock Market’s RiseEveryone likes a bull market, but it’s tough to see the stock market going up on mediocre fundamentals and a lackluster outlook. But perhaps it’s just a big ruse; perhaps corporations have been so conservative with their earnings forecasts because they wanted us to believe that we were in for a big earnings surprise. The earnings warnings we’ve had to date have been meaningful in terms of their number, but they haven’t been surprising—a lot of the companies with recent earnings warnings have industry specific issues and/or greater exposure to slowing economies like China’s. Regardless, investor sentiment has been strong enough to carry the stock market higher, even in the face of bad news; you don’t want to bet against this trend just yet.

Of course, it is an incumbent election year, which is typically favorable for the stock market. We know that interest rates are going to be low for quite some time, and we know that corporate balance sheets are strong, with reasonable stock market valuations. So with no other place for institutional investors to invest with the reasonable expectation of beating the rate of inflation (meaning dividends), why not buy stocks, even if they are trading at their highs?

There is a good amount of wealth creation going on in the stock market today, and it isn’t just because of decent earnings. There have been some very big corporate spinoffs lately, which have been a boon to shareholders. Kraft Foods Inc. has just broken up, retiring its long-time stock symbol and now trading as parent company Mondelez International, Inc. (NASDAQ/MDLZ) and spinoff Kraft Foods Group, Inc. (NASDAQ/KRFT). Breaking up very large companies into pieces unlocks a lot of new wealth for shareholders. A great example of this is the recent spinoff by ConocoPhillips (NYSE/COP) of its downstream assets into Phillips 66 (NYSE/PSX). Ever since the spinoff in April, both of these stocks have done outstandingly well, which can be seen in the charts below.

 ConocoPhillips Chart


Chart courtesy of

Phillips Chart

Chart courtesy of

This market really needs third-quarter earning season, simply because we need to hear from corporations about their business conditions. We need some hard reality in this stock market that seems to be floating up powered by hot air. (See “Should You Run From This Stock Market?”) As I’ve written, I think we’re going to get some really good upside earnings surprises that will be the catalyst that sends the stock market ticking higher until after the election. Corporations learned that they can’t stick their necks out in terms of earnings outlooks, so they’ve all been very conservative with their forecasts. Add in more share buybacks, increased dividends, and 1,550 on the S&P 500, and being conservative doesn’t seem like an unreasonable strategy, given current earnings. I keep waiting for the train wreck, but it’s not upon us just yet.