Gail MarksJarvis: The dubious side of a record stock market

McClatchy-Tribune Information Services

July 18, 2016

Who would have thought lukewarm could be so hot?

But it is. The stock market hit record levels four days in a row this week before pausing Friday. The Standard & Poor’s 500-stock index is up 5.7 percent for the year and up more than 200 percent since the scariest days of the last bear market in March 2009. If you are looking for the fabulous economic news that took the stock market out of its recent slump, you won’t find it.

Instead, stocks took a turn for the best this week simply because conditions look better than feared after the Brexit vote June 23. Now, the latest economic data on the U.S. show an economy that is OK and some U.S. companies generating more profits than investors were expecting.

But that doesn’t mean the economy is sizzling, or that companies are on a roll with their profits. In fact, as analysts look at all the large companies that make up the S&P 500, they have concluded that profits are going to decline on average for the quarter that ended a couple of weeks ago, not climb.

And it gets worse than that. The profits companies earn are expected to decline 5.5 percent for the quarter and continue a trend of four previous quarters of declines.

There hasn’t been such a lousy period for profits since the third quarter of 2008 through the third quarter of 2009, according to FactSet. And Adam Parker, of Morgan Stanley, said in a report this week that with falling oil prices, a strong dollar and modest global growth, it appears that the sales U.S. companies generate this year will barely be above 2013 levels.

Yet, investors seemed fine with that. They bought stocks and consequently pushed the stock market to record highs. It was proof the market doesn’t need a roaring economy to climb. Stocks don’t even need soaring profits, although stock prices are supposed to be based on the profits companies will be earning in the near future.

But there are times when stocks can rise simply because investors think they are seeing conditions shaping up to be better than they’ve been seeing.

After four straight quarters of declines overall in profits, analysts are expecting a sharp rebound during the second half of this year. If it happens, that momentum can carry stocks higher, but the debate among analysts is whether there’s more optimism than a slow-moving economy will provide. Parker has called the general outlook for revenue in 2017 to be "wildly optimistic."

On the positive side, analysts have been encouraged by recent strength in the latest jobs report, and retail sales numbers Friday that suggest Americans are feeling fine about spending money. Strategist Edward Yardeni noted in a report that he also likes what he’s seeing in transportation stocks.

Transportation stocks are like a thermometer that takes the temperature of the economy. Since early 2015, that thermometer has indicated sickly conditions. Think about trains, planes and trucks. They carry the stuff that people and businesses buy, so if transportation stock prices are plunging, that suggests customers aren’t buying, and the economy and stock market may be troubled. But Yardeni notes that the opposite has happened lately. Since the Brexit vote, the stocks that make up the Dow Jones Transportation index have climbed 11 percent. They are up about 19 percent from their January lows.

That still doesn’t mean transportation stocks are sitting pretty. The stocks remain down about 14 percent from the highs they hit in December 2014. But they are moving in the right direction now, and better momentum plays out well with investors. Also improving are banking stocks since JPMorgan reported earnings that were better than expected.

But some analysts are dubious that better earnings are really the reason why the stock market has been setting records.

"The rally in the stock market is not at all earnings-based," said Gluskin Sheff economist David Rosenberg in a report to clients Friday. Rather, he thinks stocks are simply going up because investors don’t see any other alternative for their money than investing in stocks.

Central banks worldwide are keeping interest rates at such "microscopic" levels that investors are being driven into stocks if they want to make money, he said. Eighty percent of the world’s bonds have yields lower than 1 percent, he said. Only 6 percent have yields more than 2 percent.