There is a direct correlation between the direction of stock prices and the anticipated direction of corporate earnings. Stock prices go up when earnings are expected to go up and stock prices go down when earnings are expected to fall. This relationship was vividly shown last week when we examined the All-Weekly graph of the S&P 500 WatchList. In my essay, I said as long as the S&P 500 EPS continues to rise, I am content to believe that we are on the road to recovery. So what are the impediments to rising earnings?

Of course, a weak economy, such as we have had for the last two years, has made it very difficult for earnings to rise. Workers have lost jobs and they have less money to spend. So the demand for goods and services has decreased and employers discharged more workers, which further reduced demand and so on. In order to reverse this vicious cycle, politicians enacted a massive stimulus bill, the Treasury Department printed tons of money and the Federal Reserve lowered the Fed Funds interest rate to essentially zero percent. Therein lies a tale.

The Federal Reserve is the key player here because it has the responsibility of maintaining a stable currency and of ensuring full employment. This is an impossible task. One conflicts with the other. If The Fed wants a stable currency, it must favor high interest rates which will slow economic growth and raise the unemployment rate. If it wants to have full employment, it will favor low interest rates which will debase the currency and invite rampant inflation. Right now, The Fed is doing all it can to stimulate the economy and reduce the unemployment rate.

Earlier this week, The Fed announced that it will keep its benchmark short-term interest rate "exceptionally low" - near zero - for a long time to come. The decision not to raise rates seems prescient given today's jobs report which said that the unemployment rate hit a 26-year high of 10.2%. But it wasn't that hard to make. The Fed never raises interest rates until after the unemployment rate has peaked and begun to go down.

So the threat of high interest rates will not impede earnings growth for the foreseeable future. What about inflation? Inflation is not a problem right now. Banks are hoarding money and inflation won't start going up until they begin lending and consumers start spending big time. So inflation, in the classic sense of higher prices for goods and services, is benign and it will not hamper earnings growth for some time to come. But there is a problem.

The weak economy, excessive government spending and loose monetary policy are driving the value of the U.S. dollar down. This is driving up the price of oil and other commodities. In the long run, high oil and commodity prices will have the same damaging effect as rising inflation and interest rates, The Enemies of Earnings.

HOW TO PICK HIGH PERFORMANCE STRATEGIES.
Once again we mine information generated by the VectorVest RealTime Derby. This time Mr. Todd Shaffer will show us a simple but effective technique of finding Strategies showing the highest performance in several ways. So join Mr. Shaffer at the VectorVest University to see this week's "Strategy of the Week" presentation: "How to Pick High Performance Strategies."