Earnings this quarter are arguably the best in 24-years. A sizable 343 companies out of the S&P 500 have reported earnings and hefty 79.9% of them have beat estimates. Despite phenomenal results, the S&P 500 is down about 1% since the start of earnings season. The fact that great earnings fail to boost stocks raises a number of questions.
First, why are healthy earnings failing to move stocks higher? Financial news pundits have pushed a number of different reasons why stocks are flopping.
Some of the credible explanations are a looming trade war with China, rising volatility and the recent climb in 10-year Treasury yields. Indeed, all of these factors do contribute to the tepid stock performance.
But there is something even more fundamental at play. The combination of corporate tax cuts and a strong economy have raised investor expectations too high.
Most of these expectations were already baked into stock valuations before earnings. The S&P 500 is still up about 25% over the last two years.
Indeed, stocks are in bubble territory according to many traditional measures. Investors recognize this and are using strong earnings to cash out their profits. Essentially, it’s a market-wide buy the rumor, sell the news type event.
What comes next after earnings fail to boost stocks?
Despite recent declines, stocks are still relatively overvalued. For instance, the price-to-earnings (PE) ratio is 52% above its historical average. Accordingly, valuations still have room to get squeezed further.
Moreover, there are no major positive catalysts for the stock market on the horizon. The first bump in earnings from corporate taxes is already in the books. The economy has seemingly peaked and growth is slowly drifting lower as evidenced by the 2.3% growth rate in the first quarter.
That means there is little impetus for investors to continue holding stocks, much less to pile into them and drive prices higher. Subsequently, the stock markets will likely continue drifting lower in the coming months. A major unexpected event, like a trade war or military action against Iran, would trigger a more pronounced exit from stocks.
Indeed, we may be at the start of a bear market. Accordingly, investors need to adjust their portfolio to protect against stock market declines.
Next week, we’ll have a special article that details some cost-effective ways to protect your portfolio against stock market declines. So make sure to check back into the Financial Courier.