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If you want more evidence that the U.S. stock market is disconnected from the actual economy, you only need to look at its performance during the third-quarter earnings season.
Since earnings season began in early October, the Standard & Poor's 500 Index, Dow Jones Industrial Average, and NASDAQ Composite Index have climbed 5.7%, 5.2%, and 6.1%, respectively. The S&P has recently closed with consecutive record highs for four trading sessions and ended above the previous close on 13 of the last 17 trading sessions.
But the actual earnings results don't support this trend.
As of Oct. 25, 244 companies had reported results. In terms of revenue, 52% reported sales above the mean estimate, below the four-year average of 59%, according to FactSet's Earnings Insight. About 75% reported earnings per share above the mean estimate, only slightly above the four-year average of 73%.
Companies, however, only beat earnings per share estimates by about 0.8% on average, drastically down from the four-year average of 6.5%.
There is a widening disconnect here between the sluggish American economy and the frenetic performance of the U.S. stock market. Money Morning Chief Investment Strategist Keith Fitz-Gerald calls this disparity "fundamental expansion."
"What this means is that the market is pricing in anticipation rather than real results, as it has done traditionally," Fitz-Gerald told Money Morning. "The markets are getting ahead of themselves."
When we look closer at the results of this earnings season, we see a different story than what the market is telling us...
Expense Reduction, Not Revenue Growth
Earnings growth this quarter remains more about cost cutting than it does about the economy at large, says Fitz-Gerald. Earnings keep going up, but revenues aren't keeping pace.
"Almost without exception, what we're seeing is gains in expense reduction without strong top line growth. If this were a real recovery, we'd be seeing strong top line growth, not just expense reduction," says Fitz-Gerald.
In other words, companies are showing increased earnings by doing more with less. While they're getting leaner and meaner, they're not really growing.
But they're getting very good at looking like they are...
PRICE DOES NOT EQUAL VALUE
Surprise, but at times of exuberance or positive investor sentiment, stock prices may not indicate or reflect true value. This "disconnect" has been known to continue or persist for some time (awhile). Sure, eventually things reset to a more "normal" valuation, but the process is unpredictable and can happen all at once (crash) or over longer periods ( sideways trading range).
Its a worry, to be sure- but not for most investors at this time. Market sentiment and financial news are still overwhelmingly bullish. Until that changes, stocks will probably keep moving to new highs no matter what the Corporate "top line" may indicate. A buoyant stock market is the primary reason Mitt Romney lost the last Presidential election and why nobody cared about ObamaCare in 2012. Voters determined the "status quo" was O.K. with them.