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Are Earnings Really Driving The Market Higher? at Trader’s Narrative

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Guest Post by Vadim Pokhlebkin

It’s corporate earnings season again, and everywhere you turn, analysts talk about the influence of earnings on the broad stock market:

  • US Stocks Surge On Data, 3Q Earnings From JPMorgan, Intel (Wall Street Journal)
  • Stocks Open Down on J&J Earnings (Washington Post)
  • European Stocks Surge; US Earnings Lift Mood (Wall Street Journal)

With so much emphasis on earnings, this may come as a shock: The idea of earnings driving the broad stock market is a myth.

When making a statement like that, you’d better have proof. Robert Prechter, EWI’s founder and CEO, presented some of it in his 1999 Wave Principle of Human Social Behavior:

Are stocks driven by corporate earnings? In June 1991, The Wall Street Journal reported on a study by Goldman Sachs’s Barrie Wigmore, who found that “only 35% of stock price growth [in the 1980s] can be attributed to earnings and interest rates.” Wigmore concludes that all the rest is due simply to changing social attitudes toward holding stocks. Says the Journal, “[This] may have just blown a hole through this most cherished of Wall Street convictions.”

What about simply the trend of earnings vs. the stock market? Well, since 1932, corporate profits have been down in 19 years. The Dow rose in 14 of those years. In 1973-74, the Dow fell 46% while earnings rose 47%. 12-month earnings peaked at the bear market low. Earnings do not drive stocks.

And in 2004, EWI’s monthly Elliott Wave Financial Forecast added this chart and comment:

comparing stron gearnings with market tops Elliott Wave chart

Earnings don’t drive stock prices. We’ve said it a thousand times and showed the history that proves the point time and again. But that’s not to say earnings don’t matter. When earnings give investors a rising sense of confidence, they can be a powerful backdrop for a downturn in stock prices. This was certainly true in 2000, as the chart shows. Peak earnings coincided with the stock market’s all-time high and stayed strong right through the third quarter before finally succumbing to the bear market in stock prices. Investors who bought stocks based on strong earnings (and the trend of higher earnings) got killed.

So if earnings don’t drive the stock market’s broad trend, what does? The Elliott Wave Principle says that what shapes stock market trends is how investors collectively feel about the future. Investors’ mood — or social mood — changes before “the fundamentals” reflect that change, which is why trying to predict the markets by following the earnings reports and other “fundamentals” will often leave you puzzled. The chart above makes that clear.

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Robert Prechter, Chartered Market Technician, is the world’s foremost expert on and proponent of the deflationary scenario. Prechter is the founder and CEO of Elliott Wave International, author of Wall Street best-sellers Conquer the Crash and Elliott Wave Principle and editor of The Elliott Wave Theorist monthly market letter since 1979.

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4 Responses to “Are Earnings Really Driving The Market Higher?”  

  1. 1 jeromek

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    Prechter forecasts for 2010-deflation, $10 oil, collapsing gold prices, after a brief rally in equities, to where we are now, then the stock market will collapse to new below march lows..etc, etc..of course he might be right, but I don’t think so..his subscribers must be dropping like nine pins this year, contrarians are only occassionally, at inflexion points right, he appears to be mostly wrong.

  2. 2 JBR

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    The chart does not agree with the conclusion, in my view.

    Look more closely. The stock market (top half) is basically leading the earnings results (bottom half) by 3-6 months. That is exactly what I’d expect.

    It’s the trend that’s the key thing. Yes, if you bought in 2000 (at the peak of both prices and earnings) you’d have been killed, but that’s because it WAS the earnings peak - and the market started anticipating the earnings declines that were coming.

    So unfortunately I don’t think this has proven anything about disassociation, on the contrary.

  3. 3 Darren

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    Love your stuff, almost always. That said, these Prechter interludes diminish your site’s credibility. Honestly - the market discounts *anticipated* future cash flows. Of course earnings peak at the market top, but if a future decline in earnings is noted from reported expectations, a drop can begin. Come on, this post feels like a Fox News report on spurious correlations in order to rile up the uneducated.

  4. 4 uempel

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    Earnings do matter very much - and so do earnings expectations. What might mess up the works is inflation respectively deflation. Having said that, earnings are the primary indicator: there is lots of research on the subject.

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