Record Stock Market Being Fuelled by Speculation, Not Earnings Growth

U.S. stocks closed out the best June in decades with momentum carrying into the second half of the year. The S&P 500 is at record levels and stocks closed at a record high on July 3, for the third day in a row. The TSX meanwhile is less than 1% off a new record close. Those record levels may not be entirely sustainable though. First, record levels are being fuelled more by speculation that the Federal Reserve will cut rates, than it is by earnings growth. And second, a third of second-quarter stock market gains came from just five companies; that kind of narrow reliance leaves the current bull market more susceptible to a correction than broad-based expansion.

The Worst May and Best June

The second quarter was a bit of a roller coaster for investors. May turned out to be the worst May for stocks since 2010. Stocks retreated after President Trump unexpectedly said he would impose tariffs on Mexican imports unless the country stemmed the flow of migrants into the U.S. Stocks also took a hit on ongoing trade tensions between the U.S. and China.

It was a totally different story in June. In fact, it was a month of records on Wall Street. The S&P 500 advanced 6.9%, notching up its best June performance since 1955. It also ended the first half of 2019 up 17%, making it the biggest gain in the first half of a year since 1997.

The party raged on for the Dow Jones Industrial Average too, rallying more than 7% in June and recording its best June since 1938! The tech heavy Nasdaq, meanwhile, advanced 7.4% in June; it’s best June since 2000.

The record levels come at a time when companies are warning that they will not be reporting strong second quarter earnings growth. Of the 113 S&P 500 companies that have provided second quarter earnings guidance, 87 have issued an earnings warning. That number is above the five-year average of 74.¹

More broadly, for the second quarter, the estimated earnings decline for S&P 500 listed companies is -2.6%. If this number holds, it will be the first time the S&P 500 has reported two consecutive quarters of year-over-year declines in earnings since the first half of 2016.

Instead of punishing stocks for the downward revisions, investors are rewarding them.

Too Narrow a Focus on S&P 500 Growth

Investors are celebrating the record run on Wall Street, but that reliance has too narrow of a focus. To say that Wall Street has placed all of its eggs in one basket is an understatement. Just five S&P 500 companies—Facebook (NASDAQ:FB), Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), Microsoft (NASDAQ:MSFT), and Disney (NYSE:DIS)—were responsible for a third of all second quarter gains.²

Three of those companies, Amazon, Apple, and Facebook have faced serious scrutiny from regulators and politicians for having potential monopolies and a lack of digital ethics.

If just a couple of those companies have a bad quarter or continue to get bad press, it could upend the entire bull market.

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Stocks are at record levels, but those lofty heights are not a result of strong, broad-based fundamentals. Those lofty valuations are pegged more to speculation than reliable earnings growth. As a result, investors could be in for a shock once second quarter results start to pour in over the coming weeks. Fortunately, the trading professionals at Learn-To-Trade.com can show you how to profit no matter what the broader markets are doing.

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Sources:

1. Butters, J. “Earnings Insight,” FactSet, June 28, 2019; https://www.factset.com/hubfs/Resources%20Section/Research%20Desk/Earnings%20Insight/EarningsInsight_062819.pdf.
2. “Stocks finish best June in decades, capping strong first half of 2019,” Washington Post, June 28, 2019; https://www.washingtonpost.com/business/2019/06/28/stocks-finish-best-june-decades-capping-strong-first-half/?noredirect=on&utm_term=.e5d3dfb277a7.

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