The stock market crushed the remaining ‘Wall of Worry” in August, as the Nasdaq 100 was up 5.8%, followed by a 3% gain in the S&P 500. Although the Dow Industrials were up just 2.2%, my favorite small-cap ETF, the Vanguard Small-Cap Growth (VBK), was up a stunning 7% for the month.
Fears of a trade war and concerns over the on-going political turmoil in Washington D.C. dominated the headlines last month, and while there were a number of high profile stocks that dropped sharply on earnings disappointments, it did not stop the market averages from making their impressive gains.
In the August 31 report from Factset they reported that “For Q2 2018 (with 99% of the companies in the S&P 500 reporting actual results for the quarter), 80% of S&P 500 companies have reported a positive EPS surprise and 72% have reported a positive sales surprise.” In their detailed analysis, they also commented that 80% of the companies reported earnings that were greater than estimates.
What a difference a year can make! In June 2017, one headline proclaimed that “U.S. Stocks’ Biggest Risk Is Corporate Profits”. Overly negative earnings outlooks or forecasts have kept many investors on the sidelines, as the market has continued to move higher. I decided very early in my financial career that using earnings or earnings forecasts was not the best way to predict a stock’s price.
I have always favored the view that investors or traders should “Follow The Charts, Not The Earnings”. There are numerous historical examples of bad earnings calls, but Enron (ENE) has to stand out as one of the worst. Unfortunately, many of their employees’ retirement accounts were destroyed when they relied on earnings forecasts.
In January 2011, two analysts published their outlook for ENE, which was then trading at 79 ¾. Their one year price target was $98. Just over a month later, the stock broke key support in the $60-area and a year later it was almost worthless. As this chart indicates, the break of the key support level completed a major top.
In my view, Investing or trading based on price targets that are determined from earnings estimates is not a successful strategy. I have much more confidence in price targets determined from chart formations or other technical methods, like starc bands, which are based on hard data. One should remember, however, that even the technical price targets are just approximations.
Last month, stocks had the best August performance since 2014. As I noted at the time, “August draws to a close, the stock market—based on the Spyder Trust (SPY)—looks ready to record the best August performance since 2000. In 2009 and 2012, the gains in August were followed by an S&P 500 return of 3.68% and 2.43% respectively”.
