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Earnings drive the markets

Just a few minutes ago before I started putting together this newsletter, we received news that our inept politicians finally struct a deal and they would vote about rising the debt ceiling on Wednesday next week. In my last newsletter rant about the debt ceiling, I expressed my conviction that in the end, the politicians will make a deal, unless they want to cut the tree branch, on which they are sitting, off under their own asses and screw themselves and us with them. I couldn’t believe that they would be that stupid, though I have no illusions about them anymore.

Based on this news, I would expect that the markets will rally next week. But the markets would rally despite the debt ceiling circus in Capitol Hill. The debt ceiling could only temporarily choke the markets but not for long. Why? Because this is all noise. None of it matters long term. This doesn’t drive the markets up or down. It only pushes them around the fair value of the markets and creates opportunities when idiots out there start panicking about a wrong issue and rush to exits. So, learn about the market and stop being an idiot. There are enough of them already.

So, what drives the markets? Earnings. But most importantly, earnings estimates! Earnings and estimates go up, the markets follow. They go down and the markets follow too.
Just recently, I saw this chart on Twitter:

earnings, bubble, cycle charting on Twitter

If you think rationally, you will dismiss this nonsensical “analysis” as total trash. If you think the markets behave based on some arbitrarily created chart describing a bubble and a real chart scaled to the tune of the cartoon to make it look like we are about to crash, because the cartoon said so, you have no place in the markets, unless you want to lose money. The idiocy in the chart above is unspeakable.

Rather than guessing and wishful thinking, gather information about the markets. And it has been proven many times that earnings drive the markets. And you will also see how retail investors deceive themselves by being uninformed.

Many times, during 2020 and 2021 retail investors were posting on social media that the market is way overbought and in a parabolic rally and doomed to crash. They were posting charts like the one above proving their point. The bear market eventually happened but not when they wanted it. And all you needed to do is to look at earnings.

earnings vs markets historical chart

If you were betting on the market crash in 2020 and 2021 because the market (blue line) was in parabola you got badly burned. A simple look at earnings (orange line) could tell you that the earnings were skyrocketing too. It is a typical behavior after any crash. Look at 2009. A sharp rebound in earnings and strong rally. And the markets followed (despite media warnings us almost every day about an imminent second recession).

And the same happened in 2020. The earnings crashed but rebounded and rallied. This time, the markets went ahead of itself and rallied more than the earnings, but the earnings rally was parabolical too. There was no reason expecting the markets to crash. When earnings finally stopped going up, the markets followed.

Today, we keep hearing from bears that the markets are bound for a second leg down. Well, unless the earnings continue to go down, this will not happen. And so far, earnings came back better than expected (80% of the companies beat their expectations) and estimates are no longer revised to the downside. And at the end of the year of 2023 earnings are being revised up. If the companies continue to beat these estimates, the markets will follow higher.

And, if we look at the shorter time frame, we can see that the markets are more pessimistic about the earnings than the earnings themselves. The markets are lagging the earnings:

debt ceiling

What is this telling you? Well, a simple thing! The markets have plenty of room to the upside. And if earnings start sloping up, expect a strong rally. And of course, the bears will get crushed on the way up, until they admit that they were on the wrong side and start the FOMO.

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