Earnings Remain the Market's Driving Force


With everything happening around the world why would anyone think stock prices in the United States have a better chance of going higher rather than lower from this point?

Let's look at the backdrop -- we have a world-wide debt crisis, major banks being downgraded, high unemployment, world-wide slowdown, stagflation setting in on every major economic power, civil war in Syria, Iran developing a nuclear bomb while threatening peace in the Middle East, Egypt in turmoil, leaks from the White House threatening national security, a growing and hostile Russia, manufacturing output dropping ... the list goes on and on. And new events unfolding everyday can add to the list.

All of these are at varying levels, ranging from bad to really serious to horrific. But, investors need to ask themselves two questions: 1) are the economic consequences of these issues already baked into the value of the stock market?; and 2) do these events have a potential negative impact on future earnings or interest rates?

We are all overwhelmed with the negative headlines but the elephant in the room is that earnings aren't that bad for US corporations. Remember that the stock market usually interprets information instantaneously and evaluates it. The market usually trades to levels based on the information that is in the public domain or thought to be announced in the future.

Earnings and interest rate direction are the key determinants for stock valuation and price. At this very moment,  stocks are 20-25% undervalued based on current earnings forecasts, and with interest rates at historic lows. If the events  listed start to disrupt earnings for companies or if rates start creeping higher, we might see stocks drop.

However, it is crucial to note that even if earnings reported in July for the second quarter are just a little weak compared with what is forecast today, we most certainly will see prices rise from here.

It sounds crazy to forecast that, but I believe that you pay a dear price for consensus on Wall Street. Right now, focus on what is important -- earnings and projected earnings. Even if they come in a little soft, stocks will rally.