 | | | | | | This Counterintuitive Pattern Tells You Everything You Need To Know About Investing In Stocks
Corporate America just finished its first quarter last week, which means they will soon reveal what their earnings are looking like.
If you predicted that earnings expectations were too optimistic and doomed to be revised downward, then you were right.
"The estimated earnings decline for Q1 2014 of -1.2% is below the estimate of 4.3% growth at the start of the quarter (December 31)," noted FactSet's John Butters. "Nine of the ten sectors have recorded a decrease in expected earnings growth due to downward revisions to earnings estimates, led by the Materials, Financials, and Consumer Discretionary sectors. The only sector that has seen an increase in projected earnings growth over this period is the Utilities sector."
Earnings and expectations for earnings are arguably the most important drivers of stocks.
So, you'd think that negative revisions would be bad news for stocks.
But, you'd be wrong.
The S&P 500 climbed to record highs as expectations for earnings came down.
And valuations don't really explain this because valuations are actually high relative to historical averages.
"The current 12-month forward P/E ratio is 15.5," said Butters. "This P/E ratio is above the 5-year (13.2) and 10-year (13.8) averages."
In the long-run, these divergences tend to work themselves out. But in the short-run, investors need to accept that weird things will happen that can't be explained rationally.
This chart from Butters illustrates stocks climbing for three months as earnings expectations fall. It reminds us that stocks will do the exact opposite of what you expect it to do for extended periods. It's everything you need to know about investing in stocks.
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