There’s never a time where you want to celebrate being correct, because you’ll miss the next move. That being said, it appears the market is supporting the notion that this entire move since February was just a correction. As you can see from the chart below, with the 0.94% move upwards on Thursday, the S&P 500 broke out from the recent string of lower highs. The chance of the market making a new all-time high this year has increased. We endured the fears of tariffs, geopolitical risks, and an economic slowdown to get to this point. I was always on the side of buying stocks at the low end of this range especially with solid earnings growth, but predictions are never certainties, so there are moments where skepticism grows. On the geopolitical front, President Trump will be meeting with Kim Jong-Un  in Singapore on June 12. Like I mentioned in a previous article, based on North Korea releasing three Americans they detained, I’m optimistic that there will be a positive outcome.

Earnings Growth Reason To Stay Optimistic On Stocks

Now that the market has broken out from the streak of lower highs, I think it’s fair to focus on the fundamentals which got us in this position in the first place. No matter how bearish sentiment gets, there’s not much justification for stocks to fall in 2018. In my opinion, your level of bullishness or bearishness depends on where you think multiples will go. Because I’m calling for a 5% to 10% increase this year, I consider myself very cautions as that implies a sharp multiple compression. I wouldn’t short stocks if they were above the January high, but I would recommend raising cash. I’ll be looking for signals of economic weakness which portend a recession is coming in 2019 and 2020, but now I’m actually looking for green shoots. All this success S&P 500 firms are seeing doesn’t stop at their bottom lines. It pushes up the consumer and the overall U.S. economy.

Bears Are Wrong To Worry About Slight Decline In Q2 Estimates

Some bears claim the chart below shows the earnings season was weak because the estimates for Q2 earnings growth fell. To be clear, since the estimates for Q1 were beaten by more than this decline, the estimates for the whole year rose. That’s why I claimed this quarter was fantastic. Specifically, out of the 449 firms which have reported earnings, 77% beat estimates which led to 24.7% growth. 74% topped sales estimates which equaled 9.3% growth. If the earnings estimates fall in the next two months before earnings season starts, Q2 earnings growth could be slightly less than Q1. However, Q3 will likely be better than them both. I think it’s completely wrong to worry about a slight decline in earnings growth.

The peak in earnings growth is already priced in since estimates for 2019 earnings growth have hovered between the high single digits and the low double digits. There’s an enormous difference between peak earnings and peak earnings growth. If earnings growth slows, but remains positive, I don’t expect stocks to fall into a bear market. This is why I have stated that investors are actually worried about a decline in earnings in 2019 when they sell stocks. That’s the only justification for selling stocks at the low end of this recent trading range.

Personally, I find it very difficult to have any certainty with how earnings growth will be in 2019. There’s certainly a reason to be skeptical about the stock market as the Fed raises rates, but I can’t go as far as to claim the earnings growth will miss expectations by a lot. There is a big difference between me being cautious about how stocks will perform next year and actively making bets on which way stocks will go. I don’t see a need to make those bets when there are far easier bets to make now such as expecting a rebound in economic growth in America in Q2.

The chart below drives home the point about the bears being wrong about worrying about the modest decline in expectations for Q2. As you can see, there was a record increase in Q1 expectations during the first month of the quarter as the tax cuts were put in the models during that period. The extremely small bar represents the changes in the Q2 earnings estimates in the first month of the quarter which was April. As you can see, other than last quarter, this very modest decline is the best performance since Q2 2011. Besides the initial help from the tax cuts, earnings have been great this year as the bar isn’t being lowered much and results are beating by more than usual.

Correcting A Mistake

In previous posts, I have looked at the FactSet chart which shows the stocks which have earnings beats. This implies great results aren’t being rewarded. That’s not exactly true. First, we have the chart below which shows generally, the more stocks beat estimates, the more their stocks rally; the worse they miss estimates, the more they fall.  Secondly, it’s important to look at how firms have done when their estimates go up and down. Guidance is everything.

153 firms had their estimates for Q2 raised after reporting. Those stocks are up 2.64% year to date which is 3.02% better than the market. 173 firms had their Q2 estimates cut after reporting. Those stocks are down 4.75% year to date. That’s an underperformance of 4.37%. As you can see, stocks are being rewarded when their estimates go up and penalized when they go down. It’s just that collectively, the market has been sluggish despite the better than average earnings beats. The narrative shifts with the changes in the S&P 500. Last week, the market was down since April 1, but now it’s up 2%. If the narrative can change based on a few percentage points of movement, it’s clearly not trustworthy. If the next three quarters are as good as this quarter, I think the S&P 500 will rise well over 10%. Don’t discount great earnings results.