Q3 Earnings and market correction may not necessarily go hand in hand.

Q3 Earnings – Those claiming a 40% or great correction is coming are suffering from recency bias. The market is healthy despite the worries about this being the longest bull market in American history.

The failed analogy to gravity in that ‘what goes up, must come down’ will only cause you to miss out on the gains. The chart below shows the increase in Q3 profits has accounted for 70% of the gains since Q1 2010.

For all the talk about buybacks powering this rally, only 6% of the gains are from share reductions. Profits power share reductions, unless they are funded by debt which is a big red flag.

Q3 Earnings and valuations are related.

Valuation increases have been responsible for 24% of the increase in stocks. Keep in mind, stocks were fairly cheap in Q1 2010.

The forward 12 month PE in Q1 2010 was in between 13 and 14 which is below the 10-year average which is above 14. Stocks became much cheaper soon afterward when analysts realized they were too bearish because the recovery had started.

Even the CAPE was only 19.92 in February 2010. That’s below where has been recently, but above the all-time average of 16.55. Many analysts, including myself, are skeptical of including data from the 1870s in the CAPE average.

The world is completely different from them. It seems silly to sell stocks now in part based on how they were valued over 100 years ago.

Update On Q 3 Earnings Expectations

Q2 earnings season is mostly over as 459 of the S&P 500 firms have reported earnings. This means buybacks can get back to their record pace and investors can focus more on economic metrics to gauge where stocks are going. Earnings estimates always matter. Economic reports can signal where the estimates will go.

80% of firms have beat earnings estimates on 26.4% growth and 74% of firms beat sales estimates on 10.8% growth. The 2nd quarter was even better than the first quarter.