Dow closed 0.56% in green after a choppy session ....

Dow closed 0.56% in green after a choppy session ....

History does repeat itself. If you don't believe it, take a moment to read the headlines below. The first set of headlines was taken from the last earnings season, which started in mid-April. The second set appeared just before the onset of this quarter's earnings season:

April 2010:

'Wall Street gets lift from higher earnings.' - AP

'JPMorgan earnings increase 55% on outlook for economy' - Bloomberg

July 2010

'U.S. stocks rise on speculation earnings will trigger rebound.' - Bloomberg

'Stocks surge on earnings optimism: Dow reclaims 10,000.' - AP

'Earnings: Investors hope for good news, look for clues to Future.' - NY Times

Are You Willing?

For those willing to read between the lines, earnings season provide a fascinating glimpse into the machinations of crowd behavior that drive Wall Street - for better and for worse.

The wonderfully frustrating thing about earnings is that they are dynamic, not static. Earnings have a mind of their own and don't necessarily adhere to the boundaries projected by economists and analysts.

And even when earnings do what they were expected to do, the stock market  may decide to decouple from the earnings-driven sentiment and surprise Wall Street.

Don't Bet on Earnings Optimism

The chart below shows the disconnect between blockbuster earnings and the stock market.

Optimism going into the January earnings season was high. Nevertheless, the better than expected Q4 2009 earnings, released in January 2010, caused a 9% decline in the Dow Jones , S&P and Nasdaq. The market didn't care that most companies beat their earnings by a wide margin.

You would think that a once bitten, twice shy attitude would be more on investors' minds going into the April earnings season. But that wasn't the case.

Based on a superficial glance at solely the bottom line, Q1 2010 earnings were rock solid. About 80% of all companies matched or beat their respective forecasts. However, looking at the market's reaction, you can't help but think that the almighty market knows something we don't. We'll discuss this more in a moment.

The simple truth is that the market showed blatantly visible cracks even before the April earnings season kicked off. On April 11, the ETF Profit Strategy Newsletter warned that 'buy the rumor, sell the news thinking might be the theme for this earnings season, as it was in January.' This was followed up with this statement just a few days later: 'The extremes recorded this week would be sufficient for a major market top.'

The Q1 2010 earnings, released in April 2010, caused the major indexes to drop as much as 17%. Unnoticed by many, the Russell 2000 Index of small companies  dropped as much as 21%. A drop of more than 20% is generally considered a new bear market.

Don't Trust Forecasts

On April 26, the day the S&P reached a secondary peak at 1,219, Bloomberg reported that U.S. stocks are the cheapest since 1990 on analyst estimates. 'Income is beating analysts' estimates by 22 percent in the first quarter, making investors even more bullish that the rally will continue after the index climbed 79 percent since March 2009.' Based on analysts' projections, Bloomberg pegged the P/E ratio for the S&P at 14.1.

Let's take a look at how ACTUAL earnings have matched up with PROJECTED earnings in the recent past.

In early 2008, when the Dow was still above 13,000, analysts projected 2009 earnings for the S&P companies to skyrocket to $113 from $83 in 2007.

In early 2009, when the Dow was around 7,000, analysts projected 2009 earnings to plummet from the previous $113 target to $40. Where did 2009 earnings end up? At $57. The moral of the story, don't get too giddy about analyst estimates and P/E ratios based on estimates.

Analysts are like a weather man that forecasts clear skies. Only after it starts raining, will he advice you to get an umbrella.

Can you trust the earnings?

We know you can't trust forecasts. But an even bigger issue is whether you can trust the actual earnings numbers.

The June issue of the ETF Profit Strategy Newsletter featured an analysis titled: 'Artificial earnings growth - How long before investors catch on?' This article highlights some of the practices corporations, in particular financials  and banks  use to inflate their earnings.

This is no small issue and is well documented even on the FDIC's failed bank list. The four biggest banks alone have over $7 trillion at risk. The articles on artificial earnings concludes that 'once the market begins to fall, the combination of falling prices and negative news will bring more oddities to the fore and create a negative feedback loop a la 2008. Bear markets are always the best auditors.'

On Monday, the Wall Street Journal reported that Bank of America admits to hiding debt. Oops, we unintentionally cheated could be the title of this story.

Bank of America claims that a number of trades that clearly did not qualify to be categorized as 'dollar rolls' were treated as such for accounting purposes. The classification error involved more than $10 billion.

On a smaller scale, Bank of America did what Lehman did before it collapsed. Interestingly, Bank of America did not volunteer that information; rather, it was a required response to a friendly letter sent by the SEC back in March.

Pieces of the Puzzle Coming Together

The more pieces of a puzzle you have, the clearer the picture becomes. The recent admission by Bank of America is just another piece. With only a few pieces left, the outline of the final picture is clear - a big roaring bear.

Prior puzzle pieces that point towards a major market top are: the extreme sentiment seen surrounding the April highs, the technical pattern of the decline which is reminiscent of the September/October 2008 meltdown, and valuations along with the Dow Jones  measured in gold .

Measured in real currency - gold - the Dow Jones has already fallen to the lowest level in decades and outlined the path for the Dow measured in dollars.

Perhaps for a little longer, Wall Street will cling to the hope that earnings will lift the market just to get disappointed yet again. Once it's raining, analysts will tell you to pull out your umbrella. In other words, in the midst of the downtrend, analysts will tell you to cut your losses.

The ETF Profit Strategy Newsletter works differently. It provides forward-looking analysis with timely short, mid and long-term forecasts along with target levels and the degree of selling that is to be expected. According to our analysis, now is not the time to be lulled asleep by the recent rally.

Source http://finance.yahoo.com/news/Will-Earnings-Sink-the-Market-etfguide-1749437861.html?x=0&.v=1

Index Value:	10,154.43
Trade Time:	4:02PM EDT
Change:	56.53 (0.56%)
Prev Close:	10,097.90
Open:	10,098.12
Day's Range:	10,073.68 - 10,187.28
52wk Range:	8,638.81 - 11,309.00