Are Stocks Approaching Their Sweet Spot?

After posting a record-breaking performance in 2013, many investors are wondering how long the momentum in stocks will continue. The market has acted sluggish in the new year so far, but that could easily change as we enter earnings season.

U.S. stocks declined on their first trading day of the year for the first time since 2008. The so-called “first five days of January” indicator also edged lower and may give some superstitious investors reason to worry. However, earnings season tends to be a good period for stocks. According to LPL Financial, stocks posted gains during the six-week period that runs from two weeks before to four weeks after Alcoa (NYSE:AA) reports its financial results since the second quarter of 2009 — the early stage of the current bull market.

“In fact, nearly 80 percent of rise in the S&P 500 Index since the second quarter of 2009 took place during these quarterly earnings periods,” said Jeffrey Kleintop, LPL’s chief market strategist. “Moreover, since the end of 2009, the entire gain in the index came during those quarterly periods, leaving nothing on average but volatility during the other seven weeks of every quarter.”

Despite the favorable track record in recent years, an unusually high number of firms have a negative outlook on earnings. A whopping 94 companies have issued negative earnings-per-share guidance, compared to only 13 companies that have issued positive guidance, according to data from FactSet. If these numbers hold, it will be the highest number of companies issuing negative EPS guidance and tie the mark for the lowest number of companies issuing positive EPS guidance since FactSet first started tracking the data in 2006.

The wave of negative outlooks is not likely to deter the bulls, as lowering the earnings bar appears to be the name of the game for the current rally. “During the first few years of the market recovery, the formula for higher stock prices was ‘beat estimates and raise guidance.’ Not anymore. Now it’s enough to beat the current quarter, and make it easier to beat the next one too by simultaneously lowering forward expectations,” said David Einhorn in a Greenlight Capital shareholder letter last year. “Beat and raise has become beat and lower and seems just as effective at driving stocks higher.”

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