It's not earnings keeping this bull market alive.
Despite a bad and likely still deteriorating picture for corporate earnings, the stock indexes have rallied to within striking distance of their all-time highs. If they're going to make it over the top, however, investors will have to stomach more bad results in the coming months.
"We're on pace for the fourth consecutive quarter of earnings declines [year over year] and the fifth on revenues," said John Butters, senior earnings analyst at research firm FactSet. "We haven't seen streaks like this since 2009."
The dismal fourth quarter was, to a large degree, a result of the tanking energy sector and a strong U.S. dollar that reduced the value of foreign earnings. The profits of were down 5.5 percent on a revenue drop of 4 percent, according to FactSet data. Excluding a huge onetime charge at utility NRG Energy, the earnings decline was 3.6 percent.
Analyst estimates for the first half of the year fell rapidly as fourth-quarter results came in, and they have continued to slide. The latest FactSet data show the average estimate for S&P 500 first-quarter earnings growth is now –8.4 percent, down from +0.3 percent as recently as the end of December. It could be the largest year-over-year decline in earnings since the third quarter of 2009. Sales are expected to decline a more modest 1.1 percent.
"The numbers came down very quickly," Butters said. "Earnings and revenues are expected to be down in the first two quarters, and new growth isn't expected until the second half."
The plunging price of oil was the single biggest factor in the poor overall performance. Fourth-quarter earnings in the energy sector fell by 72.6 percent — the worst by far of all 10 sectors in the index. Sales were down a staggering 34.2 percent.
The materials sector was the second weakest, with earnings down by 20.3 percent on a 15.3 percent decline in revenues. While rising oil and commodity prices will help companies in both sectors, prices remain very low, and producers' financial results will continue to suffer.
The only three sectors that reported positive earnings growth were all consumer-oriented. Telecom services was the top performer, with a growth rate of 80.7 percent. Excluding the results of Level 3 Communications, which recognized a onetime tax benefit of $3.3 billion, the sector's profit increase was 29.5 percent. The health-care and consumer discretionary sectors were both up 9.4 percent.
Another major factor in the overall S&P 500 earnings decline last quarter was the strong U.S. dollar, which has risen dramatically against most major currencies for the last two years. Non-U.S. revenues and earnings for multinational companies have fallen sharply in dollar terms.
FactSet data show that average earnings at S&P 500 companies with more than 50 percent of their business outside the United States were down 11.9 percent compared to a decline of 0.7 percent for companies with a majority of their sales in the United States.
"A lot of companies mentioned the strong dollar in their [fourth-quarter] reports," Butters said. "Those with more domestic exposure are doing much better on earnings than companies with global operations."
The deteriorating earnings outlook hasn't scared investors to the sidelines yet, but it is troubling. All 10 sectors of the S&P 500 are expected to have lower earnings growth this quarter, and seven are expected to have profits decline. With the Fed raising interest rates for the first time in almost 10 years and the business cycle getting more challenging for companies, financial results could become a lot more important for stock prices in the coming year.
"Earnings are always important, but in the later stages of bull markets, they can be critical," said Scott Clemons, chief investment strategist for Brown Brothers Harriman. "When the Fed takes away the punch bowl, earnings are the next driver for the market."
He added, "The problem is, the earnings picture is poor."
Clemons expects corporate earnings in 2016 to be in line with modest global economic growth and suggests that with profit margins high, the premium will be on generating top-line sales growth. Companies will be lucky to see low single-digit growth in earnings this year, and that could continue to cause volatility in stock prices.
"When earnings are challenged, there is not a lot of shock absorbers for issues like China, the Fed [raising rates] and the collapse in the energy market," Clemons said. "It's hard to escape the conclusion that we're near the end of the economic and market cycles. We're in an earnings recession."
He takes some comfort from the fact that many stocks have already reflected the downturn, noting that more than half of S&P 500 stocks were down more than 20 percent in January from their 52-week highs.
The 12-month forward price/earnings multiple for the index is now 16.4, according to FactSet. That's significantly higher than the 10-year average of 14.2 and not far from its peak of just over 17 in February.
Clemons, however, thinks there are plenty of undervalued stocks in the market. "The market is still being narrowly led," he said. "Active investors can find lots of opportunities."
Aaron Cross, a senior financial advisor at BMO Harris Financial Advisors, also thinks the recent declines in stock prices have presented opportunities for investors, though he is finding more of them outside the United States.
"If you don't believe the economy is going into a recession, this is just a pullback in momentum," Cross said. "It's going to be tough for companies to expand their margins from here, but I still think there's room for the economy to grow."
Just be prepared for some lousy numbers this quarter, experts say.
— By Andrew Osterland, special to CNBC.com