Daily Gains Letter

Weak Earnings No Threat to Bull Market Thanks to Fed

By for Daily Gains Letter |

How the Fed Is Protecting the Bull Market from Weak EarningsWith the S&P 500 and Dow Jones Industrial Average continuing to trend steadily higher, many investors are wondering if, after four and a half years, the bull market can continue. After all, the S&P 500 is outpacing profits at the fastest rate in 14 years, starting in 1999—the heart of the “dot-com” era.

How long can the S&P 500 party rage on for?

In a rational world, companies that deliver weaker earnings are punished with a lower share price, not rewarded. But that’s not what is happening: investors are willing, it seems, to pay more for a company whose earnings are flat, marginally higher, or, in some cases, lower.

The S&P 500 has climbed almost 150% since 2009 and is up 17% year-to-date. While many think the bull market is getting long in the tooth, that 17% gain represents the best year-to-date performance in 16 years.

That’s pretty impressive when you consider that 78% of the companies in the S&P 500 issued negative earnings guidance in the first quarter. Yet during the first quarter, the S&P 500 climbed more than 10%.

Ahead of the second quarter, 80% of all companies on the S&P 500 issued negative guidance. During the second quarter, the index advanced around two percent, but that had less to do with earnings and more to do with the fact the Federal Reserve said it might begin to taper its quantitative easing (QE) policy. Before America’s favorite sugar daddy threatened to hold back Wall Street’s $85.0-billion-per-month allowance, the index was actually up more than five percent.

So, during the first six months of 2013, under an umbrella of weak economic growth and high unemployment, the S&P 500 climbed 17%. The combined earnings of S&P 500 companies, on the other hand, were up just 3.6% year-over-year in the first quarter and 3.7% in the second—or 3.65% year-to-date.

That’s a pretty significant economic disconnect. But that disconnect is hardly new: the S&P 500 has, for years, in the face of high unemployment, falling median incomes, an increasing number of Americans receiving food stamps, high personal and student loan debt, and stagnant wages, continued to trend higher.

Again, that’s because well-heeled retail and institutional investors can borrow cheap money and plunk it into the markets. And they will continue to do so until the Federal Reserve states, definitively, when it will begin to reduce QE—which it won’t do, at the very least, until unemployment falls to 6.5% (if economic data is important). This means QE should remain untouched until well into 2014.

This would suit Federal Reserve chairman Ben Bernanke just fine, since his term ends on January 31, 2014. And Bernanke won’t want to disrupt the U.S. economy—or tarnish his reputation—before the new Federal Reserve chairman ascends to the throne.

Another factor could be Syria. Geopolitical tensions and any military strike would certainly mean a continuation of QE.

No matter what happens, the markets will go through rough patches over the next few quarters, but for the most part, stability will be the name of the game. This will leave the S&P 500 to continue its illogical bull run.

If you can’t beat the Federal Reserve, you might as well run in step. For bullish investors looking to take advantage of the current economic climate, there is the SPDR S&P 500 (NYSEArca/SPY), an exchange-traded fund (ETF) that corresponds to the price and yield performance of the S&P 500 Index, or the SPDR Dow Jones Industrial Average (NYSEArca/DIA) ETF.

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