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Wednesday, July 12, 2006

The myth of earnings driving the market

By Yaser Anwar, CSC of Equity Investment Ideas

Wall Street believes that the market will strengthen when earnings start rising again.

The problem with this notion is that earnings per share and short-term interest rates have exactly the same cyclical turning point.

In other words, the market rises when earnings per share go up is like saying a new bull market starts when short-term interest rates rise.

Short-term interest rates and earnings per share have exactly the same cyclical turning points.

In mid 1990 the market took off in spite of declining earnings per share. On the other hand, in 1994 the market stalled as earnings per share were in a strong up trend since early 1992. What was happening to earnings did not seem to matter.

What ignited the market in 1990 was the increase in liquidity accompanied by lower short-term interest rates. And what worried the market in 1994 was soaring commodity prices and short-term interest rates.

It looks like trends in short-term interest rates and commodity prices are much better indicators than earnings per share to assess the prospect of a bull or bear market.

** For more details on the same subject I recommend you read Dr. George Dagnino’s book Profiting in Bull or Bear Markets (McGraw-Hill publisher).

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