We're approximately halfway through the earnings season, and the numbers look good. Nearly four-fifths of S&P 500 companies that have reported fourth-quarter earnings have beaten analyst estimates, including bellwethers such as Apple
Exceptional or repeatable?
Unfortunately, if last Friday's muted market reception to a six-year high in the gross domestic product growth rate is anything to go by, investors will take quite some convincing before they agree to push this rally onward and upward. Whether it be GDP growth or corporate earnings (which aren't unrelated), the question is whether such improvements are sustainable.
As I've written here many times, I can't understand how investors already justify paying an above-average earnings multiple for stocks -- I'm referring to the cyclically adjusted price-earnings multiple here -- in the face of risks that are without precedent in their lifetime (perhaps that's part of the problem!).
Here's another number for you
There is the shambolic state of public finances, to name but one of these risks. According to Kenneth Rogoff and Carmen Reinhart, who co-authored an exhaustive analysis of 800 years of financial crises (This Time It's Different), debt levels at or higher than 90% GDP have "historically been associated with notably lower growth." Credit ratings agency Fitch estimates that the U.S.'s ratio of public debt-to-GDP ratio will reach 94% in 2011.
On top of that, the January effect doesn't favor stock investors this year. According to Deutsche Bank strategist Jim Reid, of the 30 negative performances in January by the S&P 500 since 1928, 18 were followed by a negative returns for the full year, with an average loss of 13.75%. The S&P 500 was down 3.7% last month -- Google
I'll admit I threw the January effect in as a bit of market lore -- I don't see a clear economic relationship between January and full-year returns. However, there are certainly enough fundamental problems to be concerned about that I recommend taking a defensive stance, either by underweighting the broad U.S. market or by focusing on pockets of value such as high-quality stocks.