Stock Market Warning Siren is Blaring

by Wolf Richter, Wolf Street:

Are we blinded yet by the brilliance of corporate earnings?

“Adjusted” earnings growth is 10.2% year-over-year in the second quarter, according to FactSet, based on the 91% of the companies in the S&P 500 that have reported results. The energy sector was a key driver, with 332% “adjusted” earnings growth from the oil-bust levels of a year ago.

The sectors with double-digit earnings growth: information technology (14.7%), utilities (10.8%), and financials (10.3%). The rest were single digit. Earnings in the consumer discretionary sector declined.

Revenues grew 5.1%, also led by the energy sector. At the beginning of Q2 last year, the WTI grade of crude oil traded at $35 a barrel. In Q2 this year, WTI ranged from $42 to $53 a barrel.

So the Wall-Street hype machine is cranking at maximum RPM to propagate the great news that earnings are soaring, and that this is the reason why stocks should also be soaring, and forget everything else. The hype machine carefully avoids showing the bigger picture which is dismal for earnings and ludicrous for stock valuations.

Aggregate earnings per share (EPS) for the S&P 500 companies on a trailing 12-months basis rose for the second quarter in a row. That’s the foundation of the Wall Street hype. But here’s the thing with these EPS: they’re now back where they had been in… May 2014.

Yep. More than three years of earnings stagnation. No growth whatsoever, even for “adjusted” earnings. In fact, on a trailing 12-month basis, aggregate EPS of the S&P 500 companies are down about 5% from their peak in Q4 2014. And yet, over the same three-plus years of total earnings stagnation, the S&P 500 index has soared 34%.

This chart shows those “adjusted” earnings per share for the S&P 500 companies (black line) and the S&P 500 index (blue line). Chart via FactSet(click to enlarge). I marked August 2012 as the point five years ago, and May 2014:

And these are not earnings under the Generally Accepted Accounting Principles (GAAP). FactSet uses “adjusted” earnings for its analyses. These are the earnings with the bad stuff “adjusted” out of them by management to manipulate earnings into the most favorable light. Not all companies report “adjusted” earnings. Some only report GAAP earnings and live with the consequences. But others put adjusted earnings into the foreground, and that’s what Wall Street dishes up.

Since August 2012, the trailing 12-month “adjusted” earnings per share of the companies in the S&P 500 index rose just 12% in total. About the rate of inflation – nothing more. Over the same five years, the S&P 500 Index soared 72%.

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