A Stock Market Crash Could Be Looming
The stock market can remain irrational for a while, but not forever. Eventually, fundamentals matter. Right now, the fundamentals are making a very strong case for a stock market crash in the near future.
Digging a little bit more into the details…
Don’t ever forget this: earnings matter a lot. If companies’ earnings are taking a hit, a stock market crash usually follows. Go look at any previous broad market sell-offs. You will see stocks crashing because earnings and the earnings outlook got worse.
Right now, business earnings don’t look good whatsoever.
Look at the S&P 500 companies to get a gauge on what is happening in the economy. In the first quarter of 2019, these companies reported a decline in their earnings per share year-over-year. In the second quarter of the year, something very similar happened.
At the time of this writing, about 70% of S&P 500 companies had reported their earnings for the third quarter of 2019. Guess what? Things don’t look so great.
The S&P 500 companies as whole have been reporting a decline of 2.7% year-over-year in their third-quarter earnings.
This is the first time since 2015 that S&P 500 companies have reported a decline in their earnings for three consecutive quarters.
The worst part? Earnings expectations don’t look that great either. So far, 45 S&P 500 companies have issued a negative guidance for their fourth-quarter earnings while only 19 have issued a positive guidance. (Source: “Earnings Insights,” Factset, November 1, 2019.)
Simple math here: for every one positive earnings guidance, there are almost 2.4 negative guidances.
Wall Street analysts seem awfully pessimistic too. For the fourth quarter, analysts are expecting S&P 500 companies to report a decline of 0.4% year-over-year. In the beginning of 2019, they were expecting the fourth-quarter earnings to increase by double-digits.
Dismal Earnings Lead to Solid Stock Performance?
With this in mind, look at the performance of the S&P 500. The index currently stands at all-time highs. Year-to-date, the index as surged by over 23%.
See the chart below to get some perspective:
Chart courtesy of Stockcharts.com
This Disparity Isn’t Normal & Won’t End Well
If you listen to the mainstream financial press, it will have you convinced that nothing is wrong and that the stock market can continue to go higher.
Dear reader, I only have one question to ask: Can the stock market go far without good earnings?
To me, it’s unlikely.
Just by looking at the disparity between the earnings numbers and stock market performance, I can’t help but be skeptical. It tells me that a stock market crash could be ahead.
But if you go little bit deeper, you will also find that valuations are getting expensive. Stocks are priced high relative to their historical averages.
Beyond this, economic conditions aren’t that rosy. The U.S. economy is facing headwinds and the global economy is stagnating. All of this will have an impact on earnings too.
Over the past few months, I have been preaching for capital preservation. I believe it’s one of the best investment strategies for investors. Understand that the stock market doesn’t usually go far away from the fundamentals.
At the moment, the upside on the stock market could be limited. The downside, however, could be a lot. In fact, a stock market crash could be just around the corner.