Today is the official debut of my new column titled "Financial Myths Exposed." One at a time, I will reveal why some of the most prominent mainstream beliefs have little or no basis in reality.
To kick things off, I'm starting with one of the most widely held "truisms" of Wall Street: i.e. Earnings Drive Stock Prices.
By this line of reasoning, knowing where a market's prices will trend next is simply a matter of knowing how the companies that comprise said market are expected to perform. Ipso Facto: Earnings data is the alleged Grand Poobah of fundamentals with more time spent waiting and watching for its release than the new Xbox 360.
On this, the recent news items below take it from here:
- "Sideways Market Looks For Direction: Earnings Could Point The Way... To bid stock prices higher, investors want more clues next year's economic growth will be strong." (MarketWatch)
- "Fear Not Investors. Analysts do not expect a year-end correction because the earnings support is very strong." (Wall Street Journal)
- "A record number of companies beating analysts' profit forecasts pushed the S&P 500 up 63% since March 9. The S&P's advance will probably last years, rather than months." (Bloomberg)
Now for the debunking part: First, earnings are not an accurate reflection of a company's future growth; but rather, a summary of past performance. Here, the December 2009 Elliott Wave Financial Forecast draws the following conclusion:
"Quarterly earnings reports announce a company's achievements from the previous quarter. Trying to predict futures prices movements based on what happened three months ago is akin to driving down the highway looking only in the rearview mirror. It leaves investors eating the markets dust when the trend changes."
Second, there is no consistent correlation between upbeat earnings and an uptrend in stock prices; or vice a versa, downbeat earnings and a decline in stocks. Case in point: During the 1973-4 bear market, the S&P 500 plummeted 50% while S&P earnings rose every quarter over that period.
Here again, the December 2009 Elliott Wave Financial Forecast presents a groundbreaking chart of the S&P 500 versus S&P 500 Quarterly Earnings since 1998.
As you can see, the market enjoyed record quarterly earnings right alongside the historic, bear market turn in stocks in 2000. Then again, the first negative quarter ever in 2009 preceded the powerful, nine-month rally we see today.
In the end, earnings data is either a reflection of activity in the past OR of fear/hope-based expectations of the future. Neither one is here. Neither one is now.