If you conducted a blind survey of investors, most people would tell you that corporate profits are a rarity in a landscape increasingly clouded by adverse macroeconomic factors.
Ed Clissold, the chief US equity strategist at Ned Davis Research, does not necessarily disagree. But he thinks investors take this information and draw the wrong conclusion.
It's a common misconception that historically strong earnings growth translates directly into a promising future for a company's stock, says Clissold. Rather, it argues that at such high levels, there is often nowhere where profits can be lost but fall, which does not bode well for equities. business.
To the extent that traders mistakenly interpret record earnings growth as a long-term bullish catalyst, they are preparing for a catastrophe, according to Clissold. And he really deserves listening, since he has successfully called the collapse of the December stock at a time when most investors on Wall Street were still bullish.
"When earnings growth is very high, prices are already embedded and it's not sustainable," Clissold told Business Insider by phone.
"When it comes to the expected benefits, when the beat rate is high, it is assumed that it is a good thing, but in reality, over the last six years, the market has behaved better when the beat rate was lower. "
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The fourth quarter of 2018 is an excellent example. While earnings of the S & P 500 rose 14%, the benchmark ended up falling 14%. Indeed, even if the conditions seemed favorable from the point of view of profits, the market price was perfect.
Then – when the technology stocks of mega-capitalisations were brought down and the Federal Reserve did not give investors the accommodative outlook they so badly needed – the market collapsed, putting almost end to the bull market that almost shifted in the morning. The euphoria had peaked and earnings growth was both ineffective and misleading.
But Clissold warns of another distinct trap that investors should beware of during a recession. In simple terms, when the economy contracts, disappointing results are the symptom and should not be considered as a bullish indicator. This is an essential caveat for any trader who combines earnings results to gain insights into future stock performance.
"If you go into recession, the lower beat rate is a sign of it," Clissold said. "If you're not, it's just a sign that the markets are catching their breath and that key rates should rise again, and the markets will start taking them into account."