Corporate earnings fell for the first time since 2008, the latest revised figures for U.S. GDP show. Since profits are mother’s milk for stocks, this must mean the end of the bull market is nigh, right?
The bull market could already be over, for all we know. The choppy trading we’ve had over the last couple of weeks could be the last gasps of a truly remarkable six-year run. But the bull market won’t end because corporate profits fell in the final quarter of 2014.
Sure, as a line from GDP, it sounds pretty bad. Pretax corporate earnings, adjusted for depreciation and the value of inventories, fell at a 1.4% annual rate in Q4. They slipped for the full-year, too, we learned from the GDP revision.
And, what the heck, it probably is bad.
But not for stocks.
That’s because the market couldn’t care less. GDP data from Q4 is ancient history to traders and investors. GDP revisions are great for Wall Street economists who need fresh fodder for their daily, weekly and monthly research notes, but it’s useless to anyone who needs to forecast the direction of stocks.
As is often said, the market is forward-looking. It doesn’t care where we’ve been, only where we’re going. Fourth-quarter 2014 GDP will be revised again and again, and if could point out the continuous changes to the market, it would tell you to get lost.
When it comes to corporate earnings, the market cares about two things: profits for the current quarter and profit forecasts for the following quarters.
That’s about it.
The Real Deal With Corporate Earnings
Consider that by definition, stocks have to be forward looking. In theory, stocks represent a claim on the future flow of cash paid out as dividend or kept on the books as retained earnings.
That’s why the market can often just shrug off apparently bad news.
For example, sometimes during corporate earnings season, a company will blow analysts’ estimates, but raise its forecast. On such occasions, shares in that company are more likely to rise than fall.
Another reason why the GDP data doesn’t much matter to stocks: The market doesn’t measure corporate profit growth the same way it’s measured in the U.S. GDP report.
The market only wants to know about corporate earnings for companies in the market. The S&P 500 is the most commonly used benchmark for U.S. equity performance. As such, when people talk about the market, they’re talking about the S&P 500. And, wouldn’t you know it, corporate profits for the 500 companies in the benchmark index were rather good in the fourth quarter.
As of March 20, 497 companies in the S&P 500 had reported Q4 earnings. In the aggregate, S&P 500 earnings grew 6.7%, according to data from Thomson Reuters. Indeed, eight of the market’s 10 major sectors reported year-over-year profit growth.
As we’ve heard time and time again, the market is not the economy. This is why stocks could go on an epic, multiyear bull run even as GDP barely grew and joblessness remained perniciously high.
And now the latest U.S. GDP report proves this disconnect yet again.
Hey, if you want an idea of what’s going on in the real world, don’t look to the stock market.