How long can financial relativity prop up stocks?

A Miamian may tell you the beach is just too cold in February. But try telling that to the millions of visitors escaping winter in the northeast and midwest. A beach day when it's 68 degrees is relative to the weather at home, wherever that may be.

Relativity is also the case for the financial results of America's biggest publicly traded companies. Before the second quarter earnings season began, profits at S&P 500 companies were forecast to fall 5.5 percent compared to a year earlier. Nope. So far, it turns out the second quarter wasn't that bad. According to FactSet, earnings of those companies is down less than four percent versus last year.

Down, yes. But not as bad, right?

Long-term investors know there are two ways to judge a company's financial performance – the absolute figures and the relative results. Relative to what? Relative to what financial journalists incorrectly call consensus expectations. There is no consensus, per se. There is a range of predicted results from financial analysts.

This is how financial results are judged initially. And so investors can see “better than expected” results and think a company's business is “better than expected.” (To be clear, the data for the second quarter is more accurately described as “not as bad as feared.”)

This has helped push the stock index to record highs. But these earnings results may not provide much of a stable bedrock for long. Profits are down. Stock prices are up. This is not a sustainable pairing.

Dozens more S&P 500 companies release second quarter financial results in the week ahead. If earnings continue to decline – no matter how small – compared to a year ago, it will be the fifth consecutive quarter of lower profits. While the results may be judged as relatively good, there's no escaping that earnings have cooled.

This story was originally published August 5, 2016 at 9:08 AM with the headline "How long can financial relativity prop up stocks?."