The earnings outlook is decent, but modest. According to analysts, earnings outlooks aren’t going up, so why then is the stock market ticking higher? Likely because of reasonable valuations and the fact that no other asset class offers income and the potential for capital gains. It’s a low interest rate environment and the bond market has run its course. Real estate requires a very long-term time horizon for capital gains (although there is potential for rental income) and commodities are always unpredictable and volatile. No, the stock market is moving higher because there are no other places for institutional and individual investors to put their money with the opportunity to generate a rate of return greater than the inflation rate. This is why the stock market is likely to keep ticking higher over the very near term, even with a humble earnings outlook.
With a modest earnings performance in the fourth quarter of 2011, the technology sector and the NASDAQ continue to outperform the rest of the stock market. I’ve been very surprised by this strength and the sector’s mediocre earning outlook. It’s actually quite a bullish sign. The NASDAQ has so far returned about 13% for the year, while the Dow Jones Industrial Average has returned six percent (excluding dividends). Big names like Intel Corporation (NASDAQ/INTC), Microsoft Corporation (NASDAQ/MSFT) and Cisco Systems, Inc. (NASDAQ/CSCO) are all doing great in this stock market; trading right at their 52-week highs with dividends. It’s by no means a bullish stock market, but it’s a definitely a worthy breakout.
As I say, the earnings outlook is modest. In fact, a lot of Wall Street research analysts have been lowering their earnings outlooks for the third and fourth quarters, as well as for 2013. It makes me think that the stock market is going to experience some major bumps after the Presidential election, if not before. In any event, I still wouldn’t be loading up on an index fund. It remains a stock-pickers’ market and, because economic growth in mature economies is so stagnant, earnings outlooks could change on a dime. We’ll be in for some big corporate surprises later this year. (See Choppy Trading Action Here to Stay—It’s an Index Trader’s Paradise.)
Large American corporations (not including the big banks) are very well-positioned to deal with changes in the global economy. They were already lean going into the subprime mortgage crisis and emerged with a self-imposed austerity that has improved balance sheets tremendously. While earnings outlooks and investor sentiment changes, the health of U.S. corporations keeps getting better. In my mind, this partially explains the dramatic move in share prices at the beginning of the year. Institutional investors just decided to buy stocks. They didn’t wait for fourth-quarter earning season or revised earnings outlooks. They were tired of worrying about the debt crisis in Europe. It really didn’t have a lot to do with the known fundamentals.
The NASDAQ is the leader in this stock market. The Dow Jones Transportation Average has to play some catch up or its divergence will signal an imminent correction.