The hope of price tested by the performance of profits and behavior

The stock market hasn’t been this optimistic about profits on the eve of a quarterly earnings season since the summer of 2004.

When an investor buys a stock, or a fund of stocks, they are buying the hope of future profits. That hope (and reality) drives stock prices. And investors have been willing to pay up for the prospect of profits. A forward price-to-earnings ratio compares a stock’s, or stock index’s, current price to its expected per share profits over the course of the next 12 months. It acts as a gauge of how expensive stocks are.

And using this indicator the S&P 500 Stock Index is more expensive than its 20-year average. This isn’t in the late 1990s, Internet bubble range, though.

In the week ahead, a big bank helps begin the first-quarter earnings season and the initial test of investors’ hope for profits. On Thursday, Wells Fargo is scheduled to release first-quarter financial results. In the past month, the financial sector has been the worst performing stock sector among the S&P 500 sectors. That followed a blistering rally after the election and accompanying hopes of lighter federal regulation on banks. Higher interest rates from the Federal Reserve also help the profit picture for banks.

For Wells Fargo, the week ahead is also an opportunity to regain credibility. The bank is the largest mortgage lender in the United States. Its reputation was damaged thanks to the revelation that it had been opening bank and credit card accounts that customers didn’t want or ask for. New details reported by the Wall Street Journal in the past week suggest that its past sales tactics extended beyond its retail bank business.

Wells Fargo’s stock has rallied more than 20 percent since the scandal first broke in September as it pays $300 million and counting in fines and settlements over the unauthorized accounts.

Profits may affirm the hopes of investors, but they don’t excuse bad behavior.

Financial journalist Tom Hudson, who wrote this “Week Ahead” column for Business Monday, hosts “The Sunshine Economy” on WLRN-FM in Miami. Follow him on Twitter @HudsonsView.

This story was originally published April 7, 2017 at 6:29 PM with the headline "The hope of price tested by the performance of profits and behavior."