(Harvest) Over the decades we have all learned to accept that earnings drive stock prices. Rising earnings – rising stock markets and stocks. Falling earnings – falling stock markets and stocks. In fact, there have been numerous studies, using current, future and lagging earnings, to determine an appropriate market price earnings multiple. Then standard deviations from that multiple are used to suggest a risk-on or risk-off investment climate.
With SPX GAAP earnings on the decline from $106 to $91 over the past year. We took a look at the history of stock market activity verses GAAP earnings since the 1920’s. Nearly 100 years. We found something completely different than what we had expected. As you can easily observe from the chart below the noted generalization, rising/declining markets during rising/declining earnings, does not hold up very well over time. This observation might help to explain the oddity: why growth companies, with hardly any earnings, can sell at PE multiples in the 100’s. While cyclical companies, during the same period, with the same revenues, can sell at PE multiples in the single digits.
