The Dow Jones Industrial Average closed at its first record high of the year this past week, and though it cooled off a bit on Thursday and Friday, the index is still up 5 percent in the past three months. The odd thing is that this surge has come in the midst of an earnings season in which the 30 stocks that make up the Dow are actually showing a decrease in earnings year-over-year.
"The earnings growth hasn't been particularly strong, and yet here we are at record prices," observed FactSet senior earnings analyst John Butters.
Blending the earning of the Dow components that have reported earnings with analyst earnings estimates for those few Dow earnings are yet to report, FactSet finds that the Dow is looking at earnings that have fallen 3 percent from the first quarter of last year.
For traders, that presents a riddle: How has the Dow managed to soar even as profits have sunk?
"I would definitely say the Dow is rally off of futures expectations, rather than what happened last quarter," commented Anthony Grisanti of GRZ Energy. "So guidance going forward will be extremely important."
Indeed, FactSet finds that over the next four quarters, analysts foresee earnings growth of 5.5 percent or more. That would be the strongest growth the Dow has recorded since the second quarter of 2012.
"Looking ahead, the expectation is for a pretty significant jump in earnings growth over the next couple of quarters," Butters said.
Of course, stocks are also sensitive to the continued stimulative policies of the Federal Reserve. And with 288,000 jobs created in April according to Friday's employment report, the combination of accelerating economic growth and a Fed that has no plans to raise the key federal funds rate anytime soon could be great news for stocks.
"I think the rally has been fueled by cheap Fed money plus a belief that the macroeconomic condition is improving," said Jim Iuorio of TJM Institutional Services.
Earnings season is about three-quarters finished. More earnings from Dow components will come this week, when behemoths Pfizer and Disney are scheduled to report. But at this point, a year-over-year earnings rise looks high unlikely, Butters said.
However, as long as the Fed is still prepared to help the economy, and economic data remain decent, bulls are comfortable with keeping their expectations of strong growth slightly in the future. That likely explains why an earnings decline—though it may sound bad on paper—is not proving to be a market killer.