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Why Stocks Go Down

Last update on: Feb 27 2020

It doesn’t have much to do with the election or even fears of the fiscal cliff. Only a couple of things move stocks. They boil down to people either want to pay a higher multiple for earnings than they did yesterday, or they don’t. The fact is that earnings aren’t as robust as they were coming out of the financial crisis, and earnings aren’t likely to improve over the next quarter or two. There are a number of reasons for this, but the point is investors aren’t going to pay higher multiples for stocks when they think earnings aren’t going to improve. Albert Edwards of Societe Generale does a good job explaining that, and it’s summarized here.

But more specifically, Edwards says it’s all about the fade in corporate profits, and the declining change in analyst expectations about corporate profits.

I think the key to understanding the recent breakdown of the equity market lies with profits. We have been emphasising for some time that profits are declining in the US, albeit at a much slower pace than declines seen in the rest of the world (that by the way is solely due to the lack of any fiscal tightening in the US relative to the rest of the developed world.)

In the piece Alberts quotes his own colleague Andrew Lapthorne, who makes an interesting observation about earnings season

“the outlook for earnings has been extremely poor in recent weeks. Yes, the US reporting season led to an improvement in near term (2012) earnings forecasts with the ratio of upgrades to total estimate changes for 2012 earnings rising from 44% to 50% over the past month, but earnings momentum for 2013 has slumped, dropping from 48% to 42%, leading to a major divergence between the two divergence with that of Europe). For earnings momentum to collapse during a reporting season is highly unusual, as optimistic forecasts are generally reeled in over the period between reporting seasons



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