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A Strategy for the Current Stock Market Rally

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The S&P 500 is up 15% since July 10 and up close to 50% from its March low. What’s the catalyst for recent gains? A strong second-quarter earnings season. More than 75% of S&P 500 companies that have reported earnings beat analysts’ estimates. Strong second-quarter earnings gave the minutiae-focused quarterly earnings crowd the courage to leap back into stocks. Even after the recent rally, there remains a truckload of cash sitting on the sidelines.

Cash to market value of equities still too high.

But are quarterly earnings a reliable signal of future sustainable stock gains? In this case, I think not. Closer examination of the quarterly earnings numbers shows that companies beat earnings estimates through cost cutting. Cost cutting equals layoffs. Job losses signal weaker future demand. I wouldn’t consider that a bullish signal for stocks. Less than half of the companies that have reported earnings beat sales estimates, and a quarter of those that beat estimates were in the financial sector. Sales of S&P 500 companies are down 16% over the same period last year. The only sectors that reported sales gains were health care, telecom, and the volatile financial sector. If your portfolio is still littered with stocks you’d rather not own, sell into the strength.

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Jeremy Jones, CFA

Jeremy Jones, CFA is the Director of Research at Young Research & Publishing Inc., and the Chief Investment Officer at Richard C. Young & Co., Ltd. Jeremy is a contributing editor of youngresearch.com.