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The Three Most Critical Drivers of Stock Prices

What drives stock prices? In this bull market, it’s the Fed, earnings and jobs.

Or, more specifically, it’s the size of the assets on the Fed’s balance sheet, Wall Street’s consensus estimate for earnings per share for the S&P 500 Index, and initial filings for unemployment benefits.

Amazingly, these three factors sport a 90% correlation with the weekly price swings in the S&P 500. And that’s been the case ever since the bull market began in March 2009, according to a recent analysis by Jeffrey Kleintop, Chief Market Strategist at LPL Financial.

But earnings represent the “most fundamental driver” of all, says Kleintop. And that’s music to my insecure ears, since I routinely tell you that stock prices ultimately follow earnings. Yet many of you still email me to say that you just don’t believe it. (What’s it going to take, people?!)

So why am I bringing any of this up? Because we’re at the onset of another earnings reporting season. And that means I have a brand-new opportunity to put my trusty earnings theory to the test.

Per tradition, aluminum giant, Alcoa (AA), kicked things off for us on Monday evening, beating expectations. But forget about Alcoa (go here to see why).

Instead, here’s the single most important data point we need to focus on to determine if stock prices will, indeed, head higher…

Introducing the Analyst “Error” Rate

When it comes to having an innate ability to make terrible predictions, Wall Street analysts stand right next to economists and weathermen.

According to the latest FactSet data, analysts collectively expect S&P 500 companies to report almost non-existent earnings growth of 0.7%.

If they’re right, the stock market is all but certain to suffer a setback. If they’re wrong – and earnings growth for the S&P 500 checks in higher – giddy up! This bull market is going to blast higher.

So what’s my prediction? Analysts are going to be spectacularly wrong. (And based on their past performance, the odds are in my favor. Just saying.)

Simply put, analysts are too darn pessimistic. They’re giving in to recent warnings about how the slowdown in China and other emerging markets could affect U.S. corporate profitability.

A fellow contrarian, Richard Bernstein, has my back. He recently told Morningstar’s Kevin McDevitt that “a lot of people don’t realize some of the best growth stories in the world right now are in the United States.”

Amen, brother! And those “people” include analysts.

For what it’s worth, Bernstein also adheres to the “stocks follow earnings” philosophy, saying that we’ve been in a primarily “earnings-driven market” ever since 2000. Maybe his faith in the doctrine will encourage a few of the holdouts among us to convert.

If not, the tale of the tape this quarter should do the trick. By that I mean, if stock prices march higher thanks to stronger earnings growth, nonbelievers won’t have a choice but to accept the theory as true.

Bottom line: Analysts should have stuck to their March 31 prediction, which called for earnings growth of 4.2% for the quarter. As it stands now, the bigger their error, the higher we can expect the stock market to rally. Bet on it!

Ahead of the tape,

Louis Basenese