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Record Earnings but Prices not Following

US and international stock market action has left investors feeling frustrated.  Lots of volatility but prices are pretty much flat year to date.  If you pulled a Rip Van Winkle and woke up from a 4-month nap, you missed a lot of fireworks, but your statements probably look a lot like they did on December 31st.  Yet shouldn’t prices be higher?  After all, global economic growth is alive and well and it is an incredible environment for corporate earnings.  With over 80% of companies reporting earnings for the 1st quarter of 2018, earnings growth rates for US companies (S&P 500 Index) are up over 24%! This is the strongest growth since Q3 2010 (source: Factset).

Not so fast per a study by Pension Partners.  They concluded that you cannot predict changes in stock prices based on changes in earnings.

  • Since 1989, there have been 4 years where earnings increased but US stocks were lower (1994, 2000, 2002, 2011).
  • There have been 2 years where earnings declined, and US stocks finished higher (1991 & 2007).  In 1998, US stocks were up 27% with earnings almost flat.
  • For those that want to see the data, here is a link:  https://pensionpartners.com/earnings-stock-prices-and-the-voting-machine/

Remember fear and greed drive markets in the near term.  With so much good news in 2017 including corporate tax cuts, volatility disappeared as investors bid up stock prices.  In turn, valuations of US stocks ended the year well above average.  During the 1st quarter of this year, investors were bombarded with negative news:  Rising interest rates, tariffs and trade risks with China, turnover in Trump’s Administration, Russia, etc.  Greed turned to fear, and markets corrected.

We do believe the bumpy ride will continue.  While we want to play some defense, we are not ready to abandon our pro-growth stance.  Around the globe, companies continue to increase dividends and buy back stock.  Mergers and acquisitions activity is near record highs.  Capital spending is growing.  With the strong earnings growth, US stocks are more fairly valued.  Per Factset, the forward 12-month price to earnings ratio for the S&P 500 is 16.0.  This is in-line with the 5-year average but still above the 10-year average.

This positive backdrop should support risky asset prices.  Markets are meant to be frustrating – just don’t let your feelings negatively impact your portfolio.

* * * * * Jon Giordani is Chief Investment Officer at PSG.  He provides innovative investment planning strategies to our clients. * * * * *