(Sergio Moraes/Reuters)
Rio de Janeiro's Mayor Eduardo Paes, right, hands over the city's ceremonial key to the "Rei Momo," or Carnival King Wilson Neto, at the Cidade Palace in Rio de Janeiro, February 5, 2016.
It's not too hard to feel good about stocks right now.
After a precipitous decline in January and the first half of February, stocks have staged a historic comeback and are now in positive territory for the year. The economy has showed continued signs of strength, and the Federal Reserve is on hold.
What could go wrong?
According to Erik Ristuben, chief investment strategist at Russell Investments, the future path of the stock market is contingent on one thing.
"I want to be clear: Earnings are absolutely the key for 2016," Ristuben told Business Insider. "Earnings are the only one of the three cycles that can show any significant improvement, and if that happens it will be very good for markets."
Ristuben's three cycles are the economic cycle, the interest-rate cycle, and the earnings cycle. The first two, he said, are reaching their latter stages as the Fed begins the process of hiking and GDP growth continues its slow, steady pace. The earnings cycle is the only one of the three that has a possible tailwind.
Currently, earnings are doing terribly. Corporate earnings for the S&P 500 have been declining for the past three quarters, and, according to John Butters of FactSet, the upcoming reporting season isn't going to be any different.
"For Q1 2016, the estimated earnings decline is -8.5%," Butters wrote in a note to clients Friday. "If the index reports a decline in earnings for Q1, it will mark the first time the index has seen four consecutive quarters of year-over-year declines in earnings since Q4 2008 through Q3 2009."
(Factset)
Now the logical response to that news, and Ristuben's assessment of earnings' importance, would be to assume that stock prices are set up for a collapse. Not so fast.
"The reality of the situation is that earnings faced three major headwinds over the past few quarters, and we expect that to change," said Ristuben. Ristuben's three issues were:
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The dollar: "The strength of the dollar, particularly for multinational companies, has been crushing earnings. However, dollar strength happened a while ago, so there should be a lessening of that headwind."
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Commodity prices: "Energy companies were hit with a 60% or so drawdown on earnings, there simply isn't that much downside left."
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Inventory backlog: "The backlog of product slowed down sales and earnings. And if you don't expect a recession, eventually customers are going to begin to place new orders and you'll have to turn to machines back on."