The stock market keeps surging higher, and the surprising strength of corporate profits is a big reason why.
For more than a year, analysts have been saying that U.S. companies couldn't keep boosting their profits by close to double-digit rates, as they have during the past five years. And for more than a year, companies have proven the analysts wrong by reporting sharply higher earnings each and every quarter.
It's the same story we're seeing in the second quarter earnings reports that have been coming out the last couple of weeks. They've been great for the most part. And that means more fuel for the stock market's stunning rally that just won't die.
That's because the profits that a company makes are one of the biggest pillars that help prop up its stock price. If investors think a company's profits will keep growing at a solid pace, they probably will be willing to pay a higher price for those shares just to get a piece of the good times they see coming.
And that's exactly what's been happening during the current bull market, which has pushed the Dow Jones industrial average past the once-unimaginable 8,000 barrier and has some market forecasters even talking about the Dow pushing past the 10,000 mark in the not-too-distant future.
If there's been a recurring theme to this record-breaking bull market, it's been stocks rallying on better-than-expected earnings.
So far, second-quarter profits from the nation's biggest publicly traded companies are coming in at their second-best level since the end of 1995, trailing only this year's first quarter.
Through Monday, 383 of the 500 companies that make up the Standard & Poor's 500 index have reported their second-quarter earnings, and they're up by an average of 9.4 percent, according to Zacks Investment Research.
Even more important, the earnings continue to come in better than the analysts who follow those companies are expecting. And these days, simply meeting expectations won't do much to bolster a firm's stock price. The way to push a company's stock price higher is to surprise analysts by earning more than they were expecting.
So far, 58 percent of the S&P 500 companies that have reported their earnings have managed to do just that and exceeded expectations during the second quarter, while just 23 percent have fallen short, which is a sure way for a stock to get absolutely hammered these days.
If the trend holds up -- and there's no sign that it won't -- the second quarter will be the 18th straight quarter where more of the S&P 500 companies topped analyst expectations than fell short. And to no one's surprise, the Dow has soared by 132 percent during that time.
Of course, companies are a lot more adept at playing the expectations game than they once were. Many executives now do their best to downplay their firm's prospects to analysts in hopes of keeping their earnings targets low enough that they can easily be topped.
Yet some analysts remain worried that stock prices have risen more than the strong earnings growth can justify.
"Even though the earnings generally being reported for the second quarter are excellent for this advanced stage of the economic cycle, they do not justify a 25 percent surge in the S&P 500 this year, on top of a 20 percent rise for 1996 and a 34 percent increase for 1995," says Arnold Kaufman, the editor of S&P's The Outlook newsletter.
In fact, investors are willing to pay much higher prices these days for stocks. The price-to-earnings ratio on the S&P 500 now stands at 23, which is higher than it has been at any time except 1961 and during the early 1990s, when earnings were depressed.
But there's more behind the stunning surge in stock prices than just strong earnings. A lot of other things are falling nicely into place for the stock market.
The economy is strong, but not so strong that inflation is a big threat. Instead, we have what some experts are calling a "Goldilocks economy" that's not too hot and not too cold.
That's helped keep inflation in check. Consumer prices have risen by 1.4 percent during the first half of this year, which is the lowest six-month increase in the inflation rate in 11 years. The news has been even better on wholesale prices, which actually have declined for six straight months -- something that had never before happened in the 50 years that the government has been tracking producer prices.
That, in turn, has allowed the Federal Reserve to hold interest rates steady, rather than being forced to raise them in order to cool off an economy that might otherwise grow too rapidly and spark inflation.
Plus, companies have drastically cut their costs and revamped the way they do business during the last few years, which has helped them save a bundle by weeding out inefficient products and operations. In addition, they're tapping into new overseas markets, which have been a source of solid growth while their U.S. market has been growing slowly.
One of these days, the naysayers will have their day and profit growth will peter out. The question, though, is when that day will come.