Dvorchak: Digging Deeper Into the 'Most Hated Rally'

Editor's Note: This article was originally published at 7:00 a.m. EDT on Real Money on May 17. To see Gary Dvorchak's latest commentary as it's published, sign up for a free trial of Real Money.

NEW YORK ( TheStreet) -- Last week I voiced my concern about this "most hated rally" ever, because the 2013 earnings estimate for the market has been declining rather than advancing.

Absent conditions in which earnings are getting better than expected, I cannot get enthused about the market advancing day after day. What support is there other than a higher valuation, and why is the valuation justified without better earnings?

To make the analysis fair, we do need to dig one layer deeper. Throughout 2012, we were celebrating when estimates advanced, but we also recognized that the surging earnings at Apple ( AAPL) were driving the advances. Apple is a huge weighting in the S&P 500, and it highly influences the behavior of the index in many ways. Apple's 2013 earnings estimate is being cut regularly, and we need to factor this into our analysis.

I re-ran the trend in the average S&P 500 2013 earnings estimate, with and without Apple, to see whether Apple matters. Turns out that it does, in a way.

S&P 500 Earnings Estimates Without Apple (AAPL)

You can see in the chart that the S&P estimate for 2013 has been cut regularly this year. If we pull out Apple, however, the situation becomes a wash, with the estimate remaining unchanged since the start of the year. This is somewhat good news, since a declining estimate should be bad for stocks, and certainly does not support the rally. At least the cuts are basically due to Apple.

The bad news is that the estimate is not rising. In order for me to pay up for stocks, I would like to see the estimate going up, indicating better earnings conditions.

A flat estimate could support a modest gain in stocks over the course of the year, but it certainly does not support the sort of robust rally we have now. I remain very cautious as a result.

At the time of original publication, Dvorchak had no positions in stocks mentioned.
Gary Dvorchak is a managing member of Channel Island Partners LLC, a Los Angeles-based hedge fund that manages large cap growth and growth-and-income funds. Dvorchak holds a master's degree in business administration from Northwestern University and a bachelor's degree in computer science from the University of Iowa.