EC The Earnings Enigma

Over half of companies in the S&P 500 have now reported earnings and we’re observing a familiar theme. For the fourth consecutive quarter, earnings have declined on a year-over-basis.

On the revenue front, growth has turned negative for the third consecutive quarter.

The Enigma

If earnings and revenues are supposed to drive stock prices, how can the S&P 500 be only 2% away from hitting a new all-time high?

The prevailing narrative is as follows:

1) The decline in earnings and revenues over the past year is just an energy story. The 60+% crash in Crude prices has weighed heavily on the sector, and earnings “ex-Energy” are holding up just fine.

(While the decline in Energy earnings has been a large contributing factor, it is not the only factor. Last quarter nearly 50% of companies in the S&P 500 reported year-over-year declines in earnings. Energy companies accounted for less than 7% of the Index.)

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2) The U.S. Dollar’s historic advance has been acting as a headwind to multinational company earnings. This is a transitory factor and earnings ex-Dollar are doing just fine.

(While it is difficult to say exactly how much the Dollar has been impacting earnings, there is no question that it has been a headwind. On whether it is a transitory factor, that remains to be seen but the Dollar’s advance has certainly abated in a recent months.)

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3) Earnings and revenue growth don’t have the same significance in the new paradigm of global central bank easing. With the exception of Brazil, every major Central Bank is still pursuing an easy monetary policy. This is said to be good for sentiment and multiple expansion, which are the most important drivers of stock prices in the short run.

(I touched on this concept a few months ago, see “The Voting Machine”)

Narrative vs. Reality

All of these narratives work nicely in explaining the resiliency of the stock market in the face of falling earnings and revenues. The question of course, is whether they will continue to support equity prices going forward.