One type of investor buys stocks when everyone is convinced corporate earnings will fall. He buys because he thinks profits will rise instead. Call him the contrarian.
Another type buys when everyone thinks earnings will rise, because he thinks they’ll rise even more than expected. Call him the eternal optimist.
And the 3½-year bull market may have produced a third type with a curious strategy: He expects earnings to fall but buys anyway, because he hopes it won’t matter. Call him the blind-faith investor. Or maybe just blind.
The financial reporting season has begun. Brace yourself: For three months, stock prices have risen while, in seeming contradiction, analysts have slashed estimates for earnings. Profits for July through September are expected to drop 1.3 percent, compared with a year earlier, for S&P 500 companies, S&P Capital IQ says. That would break an 11-quarter streak of rising earnings. Earlier this year, analysts had expected earnings for the quarter to rise 7 percent.
To be fair to bulls, it’s generally future quarters investors should be most concerned about, not the one just passed. But analysts have been cutting estimates for those quarters, too. They’ve lowered forecasts for earnings growth for each of the next two quarters by a third since summer, and as much as half since January.
US economic growth has slowed to an annual rate of 1.3 percent, practically stall speed. Meanwhile, the old formula that companies have used to compensate — pulling more profit out of each sale by trying to run leaner — suddenly isn’t working. You can only cut expenses and squeeze workers so much. Profit margins are falling for the first time in the recovery.
The other way US companies have posted higher profits is by selling more abroad. But many of the 17 countries that use the euro have fallen into recession. And developing countries are facing headwinds now, too.
So what’s kept stocks rising? One theory is loose monetary policy. ‘‘Central banks have singlehandedly kept asset prices elevated,’’ said Peter Boockvar, at Miller Tabak Advisors. ‘‘It’s certainly not the economy.’’
Analysts have been too pessimistic before, and investors who ignored them made money. And even if analysts are right and earnings fall, you can still make money buying stocks, though history suggests it’s risky.
In the 46 quarters since the start of 2001, earnings for the S&P 500 have fallen 15 times. Seven of those times, stock prices rose the following three months, sometimes spectacularly.
In the first quarter of 2009, S&P 500 earnings plunged 35 percent. Yet investors who were brave enough to buy stocks enjoyed an S&P 500 gain of 15 percent over the next three months. If they held on after that, they doubled their money. Investors won big if they bought after third-quarter 2001, when earnings fell 23 percent. Stocks rose 10 percent the following three months. But unlike in 2009, the next few quarters saw losses. Stocks dropped for three quarters.
Investors shrugging off weak earnings today are hoping the current period resembles 2009, but they could end up getting something like 2001.
for the Associated Press.