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5 important signals the stock market is telling you about itself

November 06, 2015

By Richard Barrington | MoneyRates.com Senior Financial Analyst, CFA

Where should you look for good information about the stock market? Financial journals, television commentators and even this website will try to shed some light on what's going on with Wall Street. Sometimes though, it is best to go straight to the source: the stock market's recent behavior and current statistics.

Here are five things the stock market seems to be saying:

1. It lacks conviction

What does it mean when the stock market can be down 4 percent one day, then rise by almost as much a few days later? When hundreds of billions of dollars of value can be created or destroyed from week to week?

What it boils down to is uncertainty. People are chasing speculation, and the lack of conviction people have in this speculation is reflected in how frequently the market has been reversing course lately.

This is a good opportunity for investors who have a solid, long-term conviction in an economic outlook or the prospects of a particular company. Market volatility increases opportunities to act on such convictions at favorable prices.

2. Current prices are heavily dependent on interest rates

A good deal of speculation surrounds what the Federal Reserve is going to do about interest rates. The market's nervousness about this topic reveals a sobering reality - market valuations are highly dependent on the current level of interest rates. Super-low rates have made the stock market look like a more attractive option by comparison. Raise the level of interest rates, and the comparison does not favor stocks as much.

This is sobering because short-term rates are already near zero. There is little room for them to fall, and thus little room for stocks to look any better by comparison. There is, however, plenty of room for rates for savings accounts and other deposits to rise, and thus ample room for stocks to look relatively less attractive.

3. It reflects a truly international marketplace

The ability of events beyond America's shores to affect the stock market shows just how global the financial and business arenas have become. For example, U.S. investor concern over China recently has centered on two things: the extent to which its currency devaluation will allow its exporters to undercut U.S. companies, and how much underlying economic weakness will dampen demand for U.S. exports.

This demonstrates that global trading partners are both sources of demand and sources of competition. You should think about both sides when you measure another country's impact on the U.S. economy. As an investor, consider whether each company you own has more to gain or to lose from the opening of foreign markets, and the health of those markets.

4. Earnings estimates should be taken with a grain of salt

Seventy percent of companies in the S&P 500 beat their earnings estimates for the most recent quarter - so why has the market been going down rather than up?

The reality is earnings estimates are somewhat static figures that do not always represent the true expectations of individuals. A lack of reaction to what should be positive earnings surprises can indicate stock prices already reflected an expectation companies would do better than their formal earnings estimates.

5. Fundamental growth has been hard to come by

If you think stock prices have been struggling, the fundamentals that support those prices have been doing even worse.

Over the current stock market cycle, a period going back nearly eight years now, the S&P 500 has climbed just 35.44 percent - a rate of less than 4 percent a year. More troubling, though, is the fact that the fundamentals that drive prices have grown even more slowly. Compared to the 35.44 percent increase in prices over the current market cycle, operating earnings are up by just 23.67 percent, and sales growth rose only 5.56 percent.

Perhaps the most revealing thing about the above clues is what they say about where the market has been. For some time, stock prices ran ahead of operating earnings, and especially ahead of the sales growth required to drive future earnings. Whatever happens going forward with China, interest rates or the U.S. economy, there remains a bill to be paid for prices getting ahead of the fundamentals.

Comment: Which signals are most important to you when investing in stocks?

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