I never saw my attorney get this close to losing his temper.

He’s a bright guy. Experienced. Resourceful. Direct. Honest. Everything you could want in an advisor.

When the conversation turned to stocks though, his frustration was visible.

Like most part-time investors, he buys what’s in the headlines. In this case it was Apple (AAPL).

He said, “I couldn’t believe it. Apple had record profits. It blew away expectations. And the stock was down.”

I could see him calculating the cost of that day in his head.

He made a common mistake.

He missed something most investors miss which often leads to large and unnecessary losses like that one and, for today’s purposes, something something that may have signaled the current market rally came to an abrupt end yesterday.

What Goes Up...

After the markets closed yesterday Alcoa (AA) released its latest earnings report.

You already know the results as you’re reading this.

As I write this, I don’t know the results though.

Despite that though, I can tell you this report and those over the next few days will give one of the clearest indicators this market rally is over, if it really is over.

You see, Alcoa’s the first major company to report earnings. It’s the the traditional start of earnings season. And everyone watches it because of how well it’s does, what happens to it’s stock price after good or bad results, and, since it’s a materials company, as an economic barometer.

At this point, expectations are pretty low.

Wall Street was expecting net earnings of two cents per share. That’s down from 28 cents during the same quarter a year ago.

The average estimate for revenues was $5.1 billion. That too is down from $5.8 billion during the same period a year ago.

Clearly, expectations are pretty low for Alcoa.

But that’s just Alcoa. Expectations are low for earnings across the board.

According to FactSet Research, analysts expect a 9.1% decline in earnings for the quarter.

That’s potentially very good for stocks or an absolute disaster.

Buying Low And Selling High

As you know, stock prices are driven over the long run by earnings.

In the short run though, they’re driven by expectations.

Four times a year earnings and expectations are forced to meet and volatility is the usual and easily foreseeable result.

This earnings season has an extra layer which could make a bad situation even worse though.

As you know, stocks are up big in the last few weeks. They’re not far from all-time highs.

Meanwhile, expectations are low. At least the officially published analyst expectations are low.

As a result of this combination of high stock prices and low expectations, we see two likely outcomes.

The first, and best, possible outcome is nothing happens.

With expectations so low, they could be easily exceeded. If that happens, we expect stock prices to hold up.

The second possible outcome is far worse.

The fear we have right now is expectations aren’t low enough. Especially in sectors like basic materials and a few international markets.

If they’re not low enough, watch out. The gains over the past few weeks will disappear fast.

If you’re anything like my attorney, it’s important not to get angry.

Just realize these scenarios before they come, be prepared for what they mean, and be ready to take what the market gives you.

We’ll cover it all here closely. Stay tuned.

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