With Emerging Market Slowing,
Corporate Earnings Are the Key

dividend paymentsIt’s my contention that the stock market is engaging in a slow process of topping out. The stock market usually likes to lead the economy and, while corporate earnings have been surprisingly strong ever since the financial crisis, this has mainly been due to growth in emerging economies. Now these economies are slowing after many years of solid expansion.

The BRIC countries along with all of Asia have been the saving grace forU.S.large-cap companies. With little growth to be had in the domestic economy, their corporate earnings have been padded by international operations. And this is the worry I have: corporate earnings growth. With emerging economies now slowing (especially in China) and virtually zero growth in Europe,U.S.corporate earnings are going to have a tough time achieving double-digit growth over the next several years. My expectation is a material slowdown in corporate earnings starting perhaps this year or in 2013, which will definitely affect the prospects for the stock market.

It is certainly possible that the U.S.economy could accelerate on its own this year. The Federal Reserve (for better or for worse) has pretty much done everything a central bank can do to try and re-inflate the economy and the stock market. (See What Could Ensure a Good Stock Market Performance This Year.) The unprecedented low-interest-rate environment is extremely helpful for corporations, with debt financing very affordable. It’s also helpful for homeowners and mortgage seekers. With encouraging signs on the employment front, the housing market should also show some improvement in the near future. But the big question is: will it be enough to satisfy the stock market? We’ll find out soon enough.

This is why I’m keener on large-cap companies that pay dividends. Income is becoming a very important part of an investor’s expectations from the stock market, especially in the age of austerity. Corporate earnings growth may slow, but companies don’t tend to reduce their dividend payments to shareholders. If times are tough, they opt not to increase the amount of quarterly dividend payouts. And we can’t forget that U.S. corporations are sitting on one of the biggest cash hoards of all time. In the absence of new investments in plant, equipment and employees, they will keep on returning their excess cash to stockholders.

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At least once a week, I study the long-term chart on the S&P 500 Index. It’s one of the best broad stock market averages. And by long-term, I’m talking about from about 1950 onward. I encourage you to do the same and see the remarkable appreciation of the index from 1985. The capital gains until year 2000 are almost unbelievable. But what’s more obvious is that the huge head and shoulders formation the index looks poised to complete. Every time I look at the index, I always wonder: is this how it is going to end?

On balance, corporate earnings in the first quarter of 2012 should be good. Visibility was cautious but hopeful last quarter. I see the stock market having more upside, but not a whole lot more unless the economic news improves dramatically. It’s going to be very difficult for U.S. corporate earnings to accelerate without domestic economic growth.