As the new season for corporate earnings reports approaches, analysts start talking about the influence of earnings on the broad stock market:
- Stocks fall slightly ahead of earnings season (The Associated Press)
- U.S. stocks open mostly lower ahead of earnings - MarketWatch
- Oil falls below $76 ahead of Q2 earnings, data (Reuters)
With so much emphasis on earnings, what you're about to read next may come as a shock: The idea of earnings driving the broad stock market is a myth.
In June 1991, The Wall Street Journal reported on a study by Goldman Sachs’s Barrie Wigmore, who found that “only 35% of stock price growth [in the 1980s] can be attributed to earnings and interest rates.” Wigmore concludes that all the rest is due simply to changing social attitudes toward holding stocks. Says the Journal, “[This] may have just blown a hole through this most cherished of Wall Street convictions.”
What about simply the trend of earnings vs. the stock market? Well, since 1932, corporate profits have been down in 19 years. The Dow rose in 14 of those years. In 1973-74, the Dow fell 46% while earnings rose 47%. 12-month earnings peaked at the bear market low. Earnings do not drive stocks.
And in 2004, our monthly Elliott Wave Financial Forecast added this chart and comment:
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. This was certainly true in 2000, as the chart shows. Peak earnings coincided with the stock market’s all-time high and stayed strong right through the third quarter before finally succumbing to the bear market in stock prices. Investors who bought stocks based on strong earnings (and the trend of higher earnings) got killed.
So if earnings don't drive the stock market's broad trend, what does?
The Elliott Wave Principle explains that what shapes stock market trends is how investors collectively feel. Social mood changes before "the fundamentals" reflect that change. That's why you'll get puzzled again and again when trying to forecast trends by following "fundamentals."
The chart above makes that clear.
"Simple logic based on external causes does not work in predicting financial markets," Bob Prechter explained in his June 2009 Elliott Wave Theorist.
Try putting social mood first. Our publications can help you do that right now, risk-free.