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The REALLY Big Myth About Earnings

Something to consider during the new earnings season

by Vadim Pokhlebkin
Updated: July 26, 2016

Earnings are out again, and analysts are again talking about the impact on the broad market.

With so much emphasis on earnings as the stock market's driving force, this next part may come as a shock: The idea of earnings driving the broad stock market is a GIANT myth.

When you make a claim like that, you better have proof. And we do.

Since 1932, corporate profits have been down in 19 years. Did stocks fall? No: The Dow rose in 14 of those years.

Conversely, in 1973-74, earnings rose 47% -- yet, the Dow fell 46%. In fact, 12-month earnings peaked at the bear market low.

But who cares about the 1930s and '70. That's ancient history, right? Things are different now. OK, then how about the very recent history: the financial crisis and Great Recession, when the stock market peaked and crashed (in 2007-2008) and bottomed (in 2009)?

Take a look at this chart from our monthly Elliott Wave Financial Forecast:

You can see that earnings were at their highest level in June 2007. Stocks were at record highs, too. The mainstream "vision" of how earnings affect stock prices demands that strong earnings should have propelled stocks even higher. Yet, the exact opposite happened: It 2007, earnings were the strongest right before the stock market's historic top.

Then, after stocks had crashed, earnings turned negative in December 2008 (actually negative, for the first time since 1935!). That should have pushed stocks even lower. Yet, the exact opposite happened: Stocks began a huge rally shortly after earnings turned negative.

Puzzling? You can say that again. But looking at "fundamentals" like earnings to forecast the broad market will get you puzzled again and again. "Simple logic based on external causes does not work in predicting financial markets," as Bob Prechter puts it.

Our monthly Financial Forecast adds:

"Earnings don't drive stock prices. We've said it a thousand times and showed the history that proves the point time and again.

"But that's not to say earnings don't matter. When earnings give investors a rising sense of confidence, they can be a powerful backdrop for a downturn in stock prices.

"Investors who [buy] stocks based on strong earnings (and the trend of higher earnings) [get] killed."

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