We’re in a bull market at the moment. So let’s talk about expectations.
Optimism about earnings growth—high expectations—is the single, critical thing that drives a bull market. As long as investors view the future with confidence, the bull stocks keep climbing. And when expectations are disappointed, they fall.
That’s the story of market trends in a nutshell.
This Bull Is Feeling Groovy
You can look at trend lines in index charts and see the market is bullish. It has been since last September.
Or, you count the gains and prove it. Since the end of August (2010), the Dow is up 21%, the S&P has advanced 26%... and Nasdaq is flying, up 32%.
The real story of the bull market, though, can be found in the headlines… the ones that should have scared investors away and didn’t.
Even Terrible News Rolls Right Off Its Back
The worst day in the market so far this year was January 28.
On that day, the world learned that thousands of Egyptians had been injured in protests in Cairo, Suez and Alexandria, Egypt.
More than a dozen died. The prime minister of 30 years and our most steadfast ally in the contentious Middle East, Hosni Mubarkek, was in trouble. He sacked his whole cabinet, but refused to resign.
Of course the stock market fell that day. But a day later, it was back to business as usual. Two days later, the Dow passed 12,000, its highest level in two years.
This is news that should be scaring investors to death. So is the threat of higher oil prices.
In London, oil prices hit a 28-month high and rose above $100 a barrel in late January.
The stock market ignored it… even though energy prices are one of the most important forces affecting many companies’ profits.
Oil prices backed off a bit lately, but none of the oil industry insiders expect that to last.
This is typical of a bull market… bad news just rolls off its back. Unless it’s bad news about earnings.
Watch Out for Disappointment Tomorrow
“Amazing” is certainly the word I would use to describe the sunny predictions of earnings growth in the next few years.
Analysts expect the S&P 500 companies to increase their earnings by an average 14% this year. And they expect to see another 14% increase next year, then 10% a year for as long thereafter as they can foresee.
If You Think the U.S. Economy Will Double In Five Years, Wall Street’s Got a Bridge for You
If the U.S. GDP could capture the projected rate of growth for Nasdaq, the U.S. economy would double in size in just five years.
The last time the U.S. saw growth like that, George Washington was in silk pants.
It would take 5 ½ years to double at the rates analysts are predicting for the S&P 500 companies. Time for a reality check.
Expectations like this are predestined to meet with disaster. Investors will be disappointed when average and large, slow-moving companies show growth rates closer to 4% than to 14%.
News from Egypt, Iraq, Afghanistan, Chile and elsewhere may not derail this bull market.
But sooner or later a series of earnings disappointments will do the trick.
Protect Yourself--Invest Where Expectations Are Undersized
Despite this caution on my part, I still think this is a good time to invest.
Bull markets can go on much longer than they “should.” It would be a shame to miss the gains a market like this can bring.
But it’s also time to make a sneak attack on the weak spots in the market.
Wherever analysts mistakenly lead investors to underestimate the potential of a company, that’s where you are most likely to see earnings surprises and sudden takeoffs in stocks that were wrongly ignored.
The trick is finding companies that are currently priced below their true worth, with earnings projection that are likely too pessimistic.
Even in a bull market such things exist because there are always a few industries that people overlook.
Lately, I have been scouting for companies and industries that analysts find boring. Places where expectations are lower than they should be… That’s where we’ll be investing this month and for as long as this bull market roars ahead.
