What to Look for Now That We're In the Sweet Spot
NEW YORK (TheStreet) -- We just hit deadlines for oil-related sanctions on Iran, for the countries in Europe to ratify the permanent bailout fund known as the European Stability Mechanism and for the Supreme Court to rule on the Affordable Care Act. This week also marked a beginning -- the start of a six-week period that has been the best for the stock market in each quarter of recent years.
While geopolitical and macroeconomic events have captured much of investors' attention, another factor has been acting quietly behind the scenes and driving U.S. stock market performance in recent years: profits. Over the past four quarters, profits for S&P 500 companies are up about 8%, as is the total return of the S&P 500. Looking back further, over the three years since earnings began to rebound from the recession in the second quarter of 2009, earnings have risen 59%. Similarly, over the past three years, from June 22, 2009, to June 22, 2012, the total return of the S&P 500 has also been 59%. That one-to-one relationship is no coincidence.
Stock market valuations, measured by the price-to-earnings ratio -- or what investors are willing to pay per dollar of current earnings -- have not changed over the past few years and remain around 12 for the S&P 500. The climb in earnings has pulled stocks higher over the past three years, not a rise in the PE ratio on increasing optimism in the durability of the business cycle, as is often the case in the first few years of a new economic cycle.
With such a heavy reliance on earnings growth, the stock market has understandably followed a pattern when it comes to the earnings season.
Earnings season pattern of performance
The stock market has again this year followed the pattern of the past two years with a solid gain of roughly 10% during the first quarter, followed by a spring slide beginning in April of at least 10%, stemming from a combination of weaker economic growth and concerns over European debt problems.
This year may also continue to follow the pattern of performance around earnings season. In the past nine quarters encompassing all of 2010 through the first quarter of this year, the S&P 500 posted an average gain of 3.14% during the six-week period beginning in the last week of the quarter (the end of the pre-announcement period) when the results of a little more than half of the S&P 500 companies are reported. During the other weeks of each quarter, the stock market has posted a loss, on average, of -1.46%.