The best analogy for last week’s decline in the stock market is a sun shower. The market was in a streak of record calmness, had one bad day, and is back to being calm just like how a sun shower comes and goes quickly. The chart below shows the changes in the VIX in the past few days. The VIX had its 16th highest 3-day rally, on a percentage basis last week. Percentages are somewhat misleading because when it starts from a low level the delta is higher. The VIX only got back to its average. Either way, it was still a burst of volatility.

The second chart shows, the three days after that volatility burst saw the 13th steepest decline in the VIX as stocks regained almost all their losses. There are many investors who are dying to get into the market, especially the ‘dumb money.’ It’s going to take more than political noise and a one-day sell-off to quell their enthusiasm. Even as a bear, I recognize that political pressures, won’t be what ends this bull run. The real worries are corporate debt levels, margins reaching a ceiling, the student loan bubble, and the auto loan bubble. If those black swans aren’t of concern, then the market will rebound based on the great Q1 earnings.

Q1 earnings, which have stabilized this market, were a thing of beauty. I’ve been skeptical of 2017 earnings because I don’t think profit margins can hit a new record. In Q1 they were just below the 2014 cycle high. As you can see in the chart below, telecom services was the only sector to miss expectations. It’s disappointing results were led by Verizon which had a 10.4% decline in earnings on a year over year basis. Without Verizon, the declines for the sector would have been 0.4%.

This chart includes 95% of earnings reports for the quarter. One of the newest reports included in the chart was Wal-Mart. The firm’s 63% increase in online sales shows the big shift in consumer discretionary purchases. Even with the demise of the apparel stores, consumer discretionary had an amazing quarter as earnings grew 5.7% which was a 7.8% outperformance over expectations. This surprised me because consumer spending was very weak in the Q1 GDP report. The first revision in Q1 GDP, on Friday, may show GDP growth to be stronger than the initial report based on this strength. I’ve been basing my perspective that the consumer is in bad shape on its high debt level, stagnant weekly earnings gains, and the weakness seen in the Q1 GDP report. This earnings data challenges that viewpoint.

The chart below shows the margin growth which I was discussing earlier. These are operating margins. The margins when including taxes and interest expenses are lower, but the point I will make is relevant for both stats. As you can see, starting in Q3 2017, new margin records are expected to be hit. That’s part of why the trailing twelve month earnings are expected to reach new highs around them. Margins cannot grow indefinitely the way earnings grow because of the intense competition in the free market. If margins break through their ceiling, I will have to review the possibilities of why this economy is different from the past. One possibility may be the uptick in regulations. The Trump administration plans to cut regulations, so this margin plateau may be stymied if that is the reason for its initial rise. I’m basing my perspective on margins on historical precedent.

The bulls will argue that this time is different. That phrase is often used as a reference to bullish investors who have irrational exuberance at the height of bull markets. I think of the term differently because this time is different in many respects. As I showed in a previous article, margin debt to GDP is at a record high and has been predicting a selloff, yet there hasn’t been one. This stock market is clearly different from the past. The question is how long margins can defy history and to what quantity. I will continue to side with history. I’d rather bet that something which has never happened in history will continue to never happen. To exemplify this point, remember the record high valuations during the tech bubble. That rally reached levels unseen, but it didn’t last. This time is different, but the differences aren’t permanent.

Getting back to the latest earnings results, you can see the big boost in Q1 earnings in the chart below. The earnings situation had become a con game during the earnings recession because estimates were being cut deeply before reporting season. This meant beats were actually bad results disguised as good results to fool the unsuspecting investor. While expectations matter when it comes to how stocks react initially after they report, if earnings endlessly decline, yet beat expectations, stocks shouldn’t rally.

You can see that the smoke and mirrors game finally ended in Q1. While earnings expectations were lowered, the actual results met the expectations from November. I encourage you, when analyzing individual stocks, to look at the historic trend of expectations when viewing earnings results. This limbo game of lowering the bar still impacts individual firms. We will see how this game plays out in Q2. As you can see, the game has started where expectations have drifted lower. They likely have further to fall over the next few weeks. If earnings can meet the expectation from January, it will show further evidence that this new earnings growth cycle has legs. Stocks would rally much higher if bottom up earnings achieved that feat.

Conclusion

It’s important to not get too caught up in the headlines because they can scare you into making irrational decisions. Politics can make the decision emotional. It’s important to have context. President Trump’s approval rating doesn’t affect earnings. The Congress can pass tax cuts whether he’s popular or not. If you’re going to sell stocks, sell them because margins are near their ceiling, not because of political noise. The reason why you sell is important because you will feel miffed after stocks rally when the political noise ends. If you raise cash because valuations are excessive, it won’t feel nearly as bad if stocks rally further. You won’t be tempted to buy at higher prices.