Michael Lombardi

The Earnings Are Here, But Stock Prices Are in Front

The stock market still wants to go up, even though investors are wary of the recent run-up (because it’s lasted so long.) But there isn’t much else for institutional and individual investors to invest in.

Big companies always get the headlines during earnings season, but there are a lot of small- and mid-cap businesses that are reporting impressive growth for the fourth quarter. It always makes me feel better when earnings are growing across the board, and not just because big companies are squeezing expenses. Smaller companies continue to be the engine of the economy and, even though they get little coverage, what they say matters just as much as the big companies.

A lot of well-respected Wall Street veterans are musing about a big bull market developing in stocks—perhaps lasting into 2013. That is a real possibility if we don’t get sideswiped by big issues like sovereign debt, or war for that matter. Right now we have a very accommodative monetary policy, recovering growth in most mature economies, and robust growth in developing economies. It’s actually difficult to make the case that corporate earnings won’t keep growing over the next few years. And it doesn’t really matter if the housing market remains in the doldrums. That’s more of a consumer issue. The growth in earnings right now is at the industrial level.

I can certainly see a new bull market playing itself out, but it isn’t going to be without some major corrections. In my view, we’re likely to get one soon. Both in equities and in commodities.

Unless there was a major new shock to the system, I would go long if there was a major selloff in stock prices. Companies are running lean operations and, with price inflation starting to wiggle its way into the economy, modest amounts of revenue growth will translate quickly into major growth in earnings. We don’t need a runaway economy. All corporations need is modest top-line growth and the earnings picture should be rosy for some time to come.

Pull up a long-term chart on the S&P 500 Index and you’ll see that ominous head and shoulders pattern jump right at you. But, if you break it down, we’ve had that similar pattern before and the market’s made out alright.

I’m predicting a stock market correction sometime between now and the middle of the year. That’s no big news. If we get a consolidation in shares prices instead and inflation stays moderate, then I think we have the makings of new bull market. It would pressure interest rates down the road, but stock prices would likely stay ahead of this certainty.

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