Kass: Putting Earnings Into Perspective

This blog post originally appeared on RealMoney Silver on June 1 at 7:26 a.m. EDT.

The ability of the U.S. stock market to continue its rally is dependent upon numerous factors, but, from my perch, the consumer holds the key.

The bearish consumer case is no longer a variant view and, as such, might be incorporated in today's share prices. It is now a widely held consensus that the consumer will be a drag on economic growth as the great debt unwind yields lower personal consumption expenditures and an elevated personal savings rate.

As well, most bearish observers hold to the notion that corporate profit margins, which, in 2006-2007, reached the highest level since the mid 1950s, are now vulnerable to mean-reversion in the years ahead. After all, the prospects for tepid top-line growth and continued cost pressures (importantly influenced by the costly burden of more regulation and the inevitability of higher corporate tax rates) seemed to point to obvious contraction.

The context of first-quarter 2009 corporate profits was telling.

Remarkably (and not well-recognized), is that over 60% of the companies in the S&P 500 missed the first-quarter consensus sales forecasts (year over year and sequentially), but, even more surprising, two-thirds of the companies beat consensus earnings expectations as aggressive cost-cutting (especially of a job cut kind) ruled the day.

While half a loaf of bread is better than no bread at all, we are left with two outcomes to consider.

The positive outcome is that when fiscal and monetary policies really kick in and aggregate demand turns, corporate profit operating leverage will result in surprisingly strong earnings.