The Mother's Milk Of Bull Markets

The State of the Market

It is said that earnings are the mother's milk of bull markets. This certainly seems to make sense as it is easy to argue that expectations for higher earnings create an environment for rising stock prices. And don't look now fans, but earnings expectations are rising.

Yes, it is true that there are times when stocks rise while earnings are actually falling. And I can provide statistical evidence to support the idea that the absolute best returns for the market occur when earnings are declining in earnest. The nadir of a recession is the poster child for this scenario.

Remember, the stock market is... everybody join in now... "a discounting mechanism of future expectations." So, while earnings typically fall during a recession, stock prices eventually begin to discount better days. And this is how new bull markets are born. In short, stocks start looking ahead and thus, prices wind up rising while earnings are still falling.

But eventually, both the economy and earnings turn up and the end to a recession becomes official - in hindsight, of course! And this is why some of the best market returns occur when earnings are actually still declining.

However, once a recession or a crisis ends, the stock market game becomes all about growth. In other words, once it becomes clear that the turn has occurred, corporate earnings have to deliver. And this, dear readers, is where I believe we are right now.

Stocks have rallied hard on the hope for a return to normalcy. The strong gains in the stock market did indeed occur while lockdowns were still in place, new Covid cases were rising, and before vaccines were even approved. As I've said a time or two over the past half-year or so, from my seat, this was a classic case of stocks looking ahead to better days.

But... Stocks can only go so far on hope alone. At some point in time, the growth that investors have been betting on needs to show up. Otherwise, stocks will have to "correct" some of that hope and adjust for reality. Thus, my take is that where earnings go from here is mission-critical for the bulls.

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The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning's opinions and viewpoints regarding the future of the markets should ...

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