How to Make Sense of This Ridiculous Market Situation

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Guest Post by Investment Contrarians

The big news for the stock market this last week was the lackluster results from Alcoa Inc. (NYSE/AA)—normally a decent barometer of global industrial activity. But what’s interesting is that the stock market rallied on the results. That goes against conventional wisdom.

Actually, Alcoa beat estimates on revenues and earnings—but just barely. I believe that the fact that Alcoa didn’t fall flat on its face was something of a major relief for Wall Street. Buoyed by an averted disaster, traders began to feel good, knowing that earnings might actually be better than they thought. 

As my readers know, while I feel there will continue to be opportunities to make money in this current Federal Reserve-fuelled stock market, my opinion is that it’s only because there’s a lack of any investment alternatives. 

About 70% of the companies on the S&P 500 will likely beat estimates. But that’s almost entirely because those estimates came from lower expectations by Wall Street. 

As I said in a recent commentary in these pages, earnings may only expand 0.7% in the first-quarter earnings season—and that’s pitiful. (Source: “Earnings Insight,” FactSet Research Systems Inc. web site, July 5, 2013.) 

At the end of the first quarter, estimates had earnings growth at 4.3% in the second quarter. That’s a pretty darn big adjustment in earnings, and it’s a growth that’s still rewarding the stock market. But it really doesn’t make sense that the stock market is still moving higher—unless you consider the abundance of cheap money and dismal bond yields. 

The data from FactSet predicts earnings growth will pick up in the third and fourth quarters, but like the second quarter, I do expect a downward adjustment in the growth expectations. 

The oddest part of this is that as long as the second-half earnings growth beats the dismal first half, Wall Street will be happy even if the numbers really stink. If the economic recovery stalls, I’m sure Wall Street will come in and move estimates lower so they are beatable. 

What all of this adjusting actually does is create an artificial earnings environment—and, in my view, that can’t be trusted. 

But, by all means, you should continue to ride the gains until the stock market decides otherwise. We are not seeing normalcy here. Investors are jumping in out of fears of missing the gains, and that’s driving the stock market higher. 

But be careful when riding this fool’s market.

by George Leong, B.Comm. 

This article How to Make Sense of This Ridiculous Market Situation was originally published at Investment Contrarians

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