Could Blow-Out Earnings Save An Overvalued Market?

As I write this, more than half the companies in the S&P 500 (59%) have reported earnings for the fourth quarter of 2020.

The results are better than expected. While companies were expected to show a decline in earnings per share compared to the fourth quarter of 2019, the companies in the S&P 500 are reporting growth in earnings of 1.7%.

That indicates the economic recovery was stronger than expected at the end of last year. This is bullish since it tells us that analysts’ optimistic expectations for 2021 are possible.

According to FactSet:

For Q1 2021, analysts are projecting earnings growth of 21.0% and revenue growth of 5.6%.
For Q2 2021, analysts are projecting earnings growth of 49.4% and revenue growth of 15.6%.
For Q3 2021, analysts are projecting earnings growth of 16.7% and revenue growth of 9.3%.
For Q4 2021, analysts are projecting earnings growth of 14.0% and revenue growth of 6.7%.
For CY 2021, analysts are projecting earnings growth of 23.4% and revenue growth of 9.0%.

While these expectations look optimistic, they may not be. Vaccines are restoring confidence and additional stimulus looks likely. These factors could drive an economic recovery.

But, in this case, a rising economic tide will not lift all boats. More than 4 million Americans have been unemployed for at least six months. That’s 39.5% of those who were unemployed in January.

Source: Federal Reserve

This is similar to the level of long-term unemployment seen during the 2008 recession, and it took almost a decade for many of those individuals to recover.

One reason long-term unemployment took so long was because many of those who were laid off in 2008 needed to switch industries to find new jobs. This can be seen in the next chart which shows the percentage of construction workers in the workforce.

Source: Federal Reserve

Looking ahead, employees in the leisure and hospitality sector could face similar struggles.

Source: Federal Reserve

Twelve years after the last recession began, construction remains below its previous peak. Restaurants, hotels and other service jobs may take years to recover as well. This means the economy will continue to struggle for some time.

What This Means For Us

As investors, this means we are back to where we were for most of last year. Stocks are bullish while the economy is weak.

It is possible stocks could go higher in the long run. But investors should focus on the short run where risks remain high.

My indicators are telling me the stock market is still risky. Below is a chart of the SPDR S&P 500 ETF (NYSE: SPY) with my Income Trader Volatility (ITV) indicator at the bottom.

ITV is interpreted like the more popular VIX Index. Increases in the indicator coincide with price declines in the stock market. At the end of last week, ITV crossed above its moving average, the dashed line in the chart. That is a “sell” signal. My Profit Amplifier Momentum (PAM) indicator confirms this signal as well.

However, money continues pouring into the stock market and that could push prices up. I’m remaining conservative and am ready to tilt bearish if major indexes decline in the next few weeks.

That’s why I’ve been saying for the past several weeks that it’s important to have a game plan in times like this.

Recently, I’ve outlined several concerns: the potential for inflation, a K-shaped recovery, and more…

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