March 26, 2019

Last year was a great year for earnings (up almost 23%), but it was also the worst year in this entire 10-year bull market for stock performance (down over 6% in the S&P 500). By contrast, 2019 is great for stocks so far, despite negative earnings growth projected for the first quarter. Why this disconnect?

The basic theory is that the stock market looks forward, but I’m not buying it. I see too many examples of wild emotional herd behavior. Investors are primarily creatures of emotion, driven by the herd. I can’t imagine a typical investor musing, “Yes, I know that earnings are down this quarter, but they might go up next year, so I’m buying stocks today in anticipation that they will go up nine months from now!”

The historical record shows that investors didn’t have the foggiest idea of next year’s earnings in advance. Did investors in 2017 stage a bonanza 30% gain because they saw 24% earnings coming in 2017?  No. Earnings weren’t forecast to be anywhere near that robust at the start of 2018. Then, did investors sell off stocks in late 2018 since they saw an “earnings recession” coming then? No, surveys at the time (shown below) showed that consensus earnings for the first half of 2019 were around +6% as of last December.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Specifically, earnings estimates for the first quarter of 2019 dropped from +5.5% at the end of 2018 to -1.5% during the week of March 14 – a 7% drop in just over 10 weeks (the blue line in the chart above). All the time these earnings estimates were declining, the S&P 500 was soaring by about 20%.

Earnings growth for the S&P 500 last year was (by quarter) +23.2%, +25.8%, +27.5%, and +14.2%, for a blended annual growth rate of +22.7%. The market declined sharply during the fourth quarter, but that was when the highest (third-quarter) reports of +27.5% were being released. The slower growth reports for the fourth quarter (+14.2%) were reported from mid-January through the end of February, when the stock market was roaring back, despite a constant lowering of corporate earnings estimates for early 2019.

Maybe the “earnings recession” reports are about to bottom out, with earnings forecasts inching up. There are some early indications that profit margins might start inching back up. The corporate tax cuts are starting to pay dividends, quite literally, in improved corporate profit margins, raised dividends, increased share buy-backs, and more tax collections, due to repatriated cash from overseas now taxed at a lower rate.

You can see the bump in S&P 500 corporate profit levels at the end of 2017 in the chart below for the three S&P indexes. Corporate profit margins made an immediate jump after implementation of the late-2017 tax bill. S&P 500 forward margins leaped from under 11% to over 12% (now 12.1%). All three margins have dipped lately, due to global growth slowdown, but they have held on to most of their gains.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Also, the Congressional Budget Office (CBO) just reported a 10% year-over-year (y/y) increase in tax collections in February. This is significant because we are just now starting to see comparative y/y results for months in which tax reform has been fully implemented. The 10% increase in February tax collections was greater than the 7.3% spending increase, so the federal government deficit declined by $12 billion in February. It’s still vital for the government to cut spending, but an increase in tax revenue is still welcome.

After Last Friday – Should You “Catch a Falling Knife”?

As of the first full day of Spring, last Thursday, the S&P 500 was up 21.43% from its Christmas Eve lows, so Thursday marked the end of “the Winter of our Least Discontent,” a huge market surge, despite the terribly frosty weather throughout much of the nation, ever-sinking earnings expectations (see above), and the threat of a Mueller probe that could have ended the Trump presidency – but instead turned out to be a dud with no recommended indictments (that news came out after the market closed on Friday).

Investors hate to grab for a “falling knife.” They hate to invest in stocks as they are falling, as they did last December – or last Friday, for that matter. They are even more averse to investing after a 55% crash in 17 months (March 2009) or a 22% crash in one day (1987) or a 45% crash in 21 months (1973-74) or a double-dip inflationary recession (1980-82). But the recoveries in the following decades are phenomenal.

In the 10 years since this bull market began in March 2009, the annualized return on the S&P 500 stock index has been 17.8%. That’s better than the three previous 10-year recoveries from similar bear market lows. Following the bear market that ended August 1982, the 10-year annualized return for the S&P 500 was +17.6%. Over the 10 years following the October 1987 crash, the S&P 500 returned an annualized +17.2%, and after the disaster that ended in October 1974, the 10-year annualized return was +15.6%.

Was Friday the end of this rise? Probably not. After each of the previous 10-year leaps (1974-84, 1982-92, 1987-97), there were at least two more good years. Bull markets don’t die on specific timetables.

The message of history is that bull markets die in a state of euphoria with sky-high P/E ratios in a bubble market mania in which nearly everyone is invested, with expectations of 20% or more annual gains. None of those earmarks identify this market, which remains the most “unloved” bull market of our lifetimes.

About The Author

Gary Alexander
SENIOR EDITOR

Gary Alexander has been Senior Writer at Navellier since 2009.  He edits Navellier’s weekly Marketmail and writes a weekly Growth Mail column, in which he uses market history to support the case for growth stocks.  For the previous 20 years before joining Navellier, he was Senior Executive Editor at InvestorPlace Media (formerly Phillips Publishing), where he worked with several leading investment analysts, including Louis Navellier (since 1997), helping launch Louis Navellier’s Blue Chip Growth and Global Growth newsletters.

Prior to that, Gary edited Wealth Magazine and Gold Newsletter and wrote various investment research reports for Jefferson Financial in New Orleans in the 1980s.  He began his financial newsletter career with KCI Communications in 1980, where he served as consulting editor for Personal Finance newsletter while serving as general manager of KCI’s Alexandria House book division.  Before that, he covered the economics beat for news magazines. *All content of “Growth Mail” represents the opinion of Gary Alexander*

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