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Corporate America will still Struggle to the end of 2020

(Wed, 19 Aug 2020). Earnings season is almost over, and while it had some positive surprises, corporate America will still struggle through the end of the year. Wall Street has not only survived a disastrous earnings season but has actually thrived. The party might not last much longer.

Earnings season is almost over. While there were no big negative surprises, the earnings drop has sent valuations soaring. Traders are driving markets higher even as fundamentals take much longer to recover. With about 90% of earnings season over, the stock market can breathe a sigh of relief. Most companies beat their expectations, truly surprising investors to the upside. If that hadn’t happened, we might be amid another market decline right now.

 

All’s Not Well Behind Earnings Season

However, that doesn’t mean the economy gets the all-clear sign. It doesn’t. Traders knew earnings would be off. So did Wall Street analysts, who managed to cut their expectations so low that any company that still had a pulse could clamber right over. The second quarter is, by far, setting a record in terms of surprise earnings numbers relative to expectations—by a factor of at least three.

That’s huge. We were flying blind going into the quarter, and things ended up being better than the most pessimistic projections. That’s worth a cheer, or even two. But not three. Why? Because we’re back to February’s all-time high in terms of price. But the market valuation has exploded higher as earnings have dropped. It doesn’t matter how you measure it, whether in price-to-book, price-to-sales, or price-to-earnings. Unless you mine gold or are working on something that can kill Covid-19, prices are up, but everything else is down.

One thing is clear: Traders have never paid so much for so little, at least in terms of corporate earnings. Historically, this doesn’t end well. We’re already at valuations associated with the real estate and tech bubbles, and earnings estimates continue to decline. Typically, there’s one last surge in PE ratios when the bubble bursts. At least now, we’re at zero percent interest rates, which still makes the stock market look like the best game in town–just like last time rates hit zero percent.

 

Where Do We Go From Here?

We could see markets fall from here. Hedge funds are starting to make that bet. A more realistic outcome from here is that markets end up stalling. They may not stall completely, as traders rotate from recently high-flying names to more relative values. But the overall effect could be a sideways market.

That could potentially even occur for as long as 12-18 months while the economy works to heal from its recent self-inflicted shutdown wounds. The record quick bounce in stock prices could simply be an effect from the rapid monetary and fiscal stimulus.

As long as interest rates are zero, or thereabouts, however, investors will likely keep the stock market from falling too much, at least for a prolonged period.

There’s simply too much money seeking a positive return, and even with the volatility of stocks, it’s a far more likely to produce a return than the safety of fixed income right now, especially with inflation expectations rising. But the aggressive money in this market rally may have already been made.

 

 

 

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