Growing Disconnect Between Market Fantasy and Reality

Jamie is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I don’t fare very well in a market like we are seeing of late.

While the stock market is roaring higher on the theme de jour the underlying fundamentals are showing cracks in a major way.

Buyers should take heed. I'm seeing some bizarre behavior in stocks including the 20% decline in the stock that shall remain nameless, but I think you know of whom I speak.

The moves higher in the last few sessions including a triple digit gain in the Dow last Tuesday morning are irrational and I have the evidence to prove it.

For the handful of companies reporting earnings in the past week, the news has not been pretty. Even more telling is the reaction of the market to good news. Surprise, surprise investors are punishing stocks reporting solid and positive results.

It’s like a virus that sits in the body waiting to harvest to wreak havoc down the road. Oh sure there may be signs of illness – an ache or pain here or there, a runny nose, a sore throat. It all starts so innocently enough.

In the case of the stock market the majority of stocks, in the absence of specific earnings news are simply ignoring the signposts ahead. Instead, there is enthusiasm – for what only god knows.

Think about it: Is a fiscal cliff deal all that to be thrilled about? Not really if one considers that there will be higher taxes and less spending.

Last week, auto retailer Pep Boys (NYSE: PBY) released earnings showing an operating loss in the period. Shares plunged by 10% on the news. In what had to be one of the most poorly written press releases for an earnings report the company failed to state explicitly what earnings would have been ex one-time items.

Doing so might not have precluded the stock from losing value, but it surely would have softened the blow. Just look at some of the headlines based on earnings that included the one-time items. It reads like a horror story. No wonder investors sold the stock.

By my reckoning, Pep Boys actually beat expectations. Analysts expect the company to make 48 cents per share in the current fiscal year ending January 31, 2013. Profits are expected to jump 27% in the following year to 61 cents per year.

You can buy that 27% growth for just 16 times next fiscal year estimated earnings.

So the stock goes down on the negative headline that may or may not be accurate. In my opinion the action is a sign of a very edgy market. Stocks may be going up, but when reality comes in the form of earnings a different story is emerging.

Another example is the trading in gun maker Smith & Wesson (NASDAQ: SWHC). Smith & Wesson reported earnings Thursday after the market closed. It could not have been a more positive report.

The company reported earnings and revenues that exceeded expectations and they raised guidance for the future. The icing on the cake was a stock buyback of some substance. Shares jumped by 5% in the after-hours market.

By the time the market opened on Friday all of those good feelings evaporated. By mid-morning the stock was solidly negative and things only got worse throughout the day. By the close on Friday shares were down 8.5%.

What went wrong? It’s not like Smith & Wesson was trading at a nosebleed valuation. Investors simply focused on the one piece of negative news it could find in the report – sales growth momentum may not be sustainable. Such a highly speculative call should be interpreted as simply the market looking for any reason to sell.

The bears are likely to get burned. The tragedy in Newtown has the nation abuzz with gun control talk. There will very likely be a spike in sales given the potential for restrictions down the road.

On Tuesday this week we see more of the same with Dollar General (NYSE: DG). The discount retailer offered its own supposedly positive report. They beat earnings and met revenue expectations. They also affirmed guidance for the year, but they did not some caution was warranted for the rest of the year.

Down she goes. That note of caution was more than enough to spook investors. Shares fell by more than 6%.

Considering that Dollar General is cheap relative to expected growth, the selling is hard to explain.

As I said, there is a dichotomy between index stocks going up and stocks in the trenches reporting earnings. It doesn’t make sense and to me demonstrates the underlying weakness in the overall market.

The party goers are saying facts be damned and buying stocks, but not when earnings come out even if that earnings news is positive. They are looking for any reason to sell.

Be careful out there, it is dicey indeed.

jamdlu has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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