Friday, July 31, 2009

Above Expectations in Earnings and GDP Mean Stocks Will Continue Higher

The answer to yesterday's question about whether better-than-expected earnings would lead to better-than-expected GDP is, "Yes." Thankfully, the deepest recession since the Great Depression may be coming to a close. Government data show that second quarter GDP fell by only 1%, less than the 1.5% consensus estimate. However, all the news was not good. Two important pieces of bad news came in the form of 1) less than expected consumer spending, and 2) first quarter GDP was revised downward. Having said this, we believe that the economic bears will gradually come off their doomsday prognostications and realize that, at least for the next few quarters, economic GROWTH will reappear. Mainstream strategists are now asking themselves, "What kind of growth can we expect over the next few quarters?" And importantly, "Can growth last after the massive government bailouts are withdrawn?" While these are tough questions, we believe the better question is, "What will corporate earnings look like over the next few years?" The reason for this is simple. S&P recently released data showing that S&P 500 companies now generate over 50% of their earnings from outside the United States. As it relates to stocks, then, the greater question is, "What will worldwide economic growth be compared to US growth?" We have been thinking about this a lot, and we will have a special report on the subject of earnings in the weeks ahead. We believe there are some surprises coming that investors may not have factored into their thinking--earnings growth in the coming years might be higher than many investors expect. We believe this better-than-expected GDP report will lead to a continuation of the recent up-leg for stocks. The market won't go straight up, but on balance, the earnings news will continue to be good and so will stock prices. The earnings derby is winding down with nearly 70% of companies now having reported. Three key elements were again present in earnings reports for this week: 1) Earnings surprises continued at a 75% rate, 2) Average earnings surprises were near 10%, 3) Earnings surprises were present in all major stock market sectors. We continue to believe that the 2008-2009 bear market for stocks has ended and that a new bull market is underway. In addition to the special report on earnings, we will have a second special report on the "fair value" of the Dow Jones Industrial Average in the coming days.