Stocks Aren’t Reflecting Improving Earnings

An article in Bloomberg addresses the question as to why “impressive corporate earnings results nor the synchronized pickup in global growth nor record levels of stock buybacks by companies has led to impressive gains in stocks.”

According to the article, written by Allianz chief economic adviser Mohamed El-Erian, among the various potential reasons for this “decoupling,” there are three that “have an important implication for what likely lies ahead for investors”:

  1. “Positive developments are already priced in, so there is no real decoupling.” When viewed over a two-year period, he points out, the divergence between fundamentals and prices are not all that dramatic.
  2. Concerns regarding sustainability—El-Erian writes that a more concerning view is that “the pause in market prices this year goes beyond mean reversion and reflects mounting concerns about the durability of improved economic and corporate conditions.” Some areas of the global economy, he writes, are already showing signs of losing momentum.
  3. “Those most concerned about sustainability,” writes El-Erian, “also worry about the policy transition in central banking.” He says that central banks have been “stepping back from the practice of repressing financial volatility at the first sign of market instability,” and this leads to an increased risk factor for stocks.

“I strongly suggest,” El-Erian concludes, “that all three hypotheses are in play today, with their relative contributions declining as you work down the list. Although this might not provide a sufficiently unique answer for many investors, it contains an important insight.”