Earnings season is upon us and that means lots of speculation about which companies will outperform and which will underperform. This is the standard every time earning season comes around. However, this season we are hearing a few different types of speculation which are worrisome. I speak of the speculation of peaking margins.
If the speculators are correct, expect some bad earnings. When you see margins peak, corporate profits will fall. Essentially when margins peak, it is a bubble burst for corporate profits. At least this is all true in theory but by historical means, we have seen margins peak before while the stock market continues to advance.
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If you look at all the years in the past that we have seen falling margins, you would see that eight out of those eleven years, stocks continued to advance like nothing was wrong. However, three of those years saw a double digit decline in stocks once margins peaked. This means that most of the time in the past, stocks kept moving but every once in a while we got smacked by the market reacting harshly to the peak.
This could be the final straw for this rally to turn into a correction. I have long been a believer of a coming correction. You simply can not sustain the gains that we have seen since the beginning of this year and expect to continue the run. Economic reports have been good lately but not surprising and if investors are concerned about the peaking margins, you can expect a correction.
The main thing to take away from this article is that earnings are expected to be not as stellar as we have seen in the past which gives people the hint that we are seeing the changing of cycles. We have had high flying, impressive corporate earnings for years now and it is time for the cycle to change, unfortunately.
That does not mean go out and sell everything. It means buying protection for your stocks and getting ready for any potential downside as well as upside. Remember that 8 out of 11 times when margins peaks, stocks kept advancing. Since we are in rally mode for the duration of this year so far, maybe we will just continue rallying and then “sell in May, go away” could be something to take serious this year. Bottom line here is the market will most likely continue to rally and if we see April as another rally month, then I would follow to old saying, “sell in May, go away”.