Best of the Week
Most Popular
1.Are UK Savings Interest Rates Finally Starting to Rise? Best Cash ISA 2017 - Nadeem_Walayat
2.Inflation Tsunami - Supermarkets, Retail Sector Crisis 2017, EU Suicide and Burning Stocks - Nadeem_Walayat
3.Big Moves in the World Stock Markets - Big Bases - Rambus_Chartology
4.The Next Financial Implosion Is Not Going To Be About The Banks! - Gordon_T_Long
5.Why EU BrExit Single Market Access Hard line is European Union Committing Suicide - Nadeem_Walayat
6.Trump Ramps Up US Military Debt Spending In Preparations for China War - Nadeem_Walayat
7.Watch What Happens When Silver Price Hits $26...  - MoneyMetals
8.Stock Market Fake Risk, Fake Return? Market Crash? - 2nd Mar 17 - Axel_Merk
9.Global Inflation Surges, Central Banks Losing Control and Triggered the Wage Price Spiral? - Nadeem_Walayat
10.Why Gold Will Boom In 2017 - James Burgess
Last 7 days
What are the Biggest Gambling Markets in the World? - 30th Mar 17
Stock Market Mixed Expectations As Technology Stocks Reach New Record Highs - 30th Mar 17
Bitcoin Price Rises Higher Than Gold… But Its Value Is a Different Story - 30th Mar 17
Critical Fibonacci Extensions May Mark End Of Trump Stock Market Rally - 29th Mar 17
Ending Syria’s Nightmare will Take Pressure From Below - 29th Mar 17
Charts That Reveal US Real Employment Status and It’s Not Good - 29th Mar 17
SNP Controlled Scottish Parliament Demands Right for Scotland to Commit Suicide - Indyref2 - 29th Mar 17
USD Gold Myriad of Signs - 28th Mar 17
Ominous Social Trends That Will Shape Our Future - 28th Mar 17
Foundation And Empire: Is Donald Trump The Mule? - 28th Mar 17
Top Ten US Dollar Risks - 27th Mar 17
The Popularity of Gambling and Investing Amongst Students - 27th Mar 17
Is Political Betting on the Rise? - 27th Mar 17
US Stock Market Consolidation Time - 27th Mar 17
Russia Crisis - Maps That Signal Growing Instability and Unrest - 27th Mar 17
Goldman Sachs Backing A Copper Boom In 2017 - 27th Mar 17
Foundation – Fall Of The American Galactic Empire - 27th Mar 17
Stock Market More Correction Ahead - 27th Mar 17
US Dollar Inflection Point - 27th Mar 17
Political Week Presurres US Stock Market - 25th Mar 17
London Terror Attack Red Herring, Real Issue is Age of Reason vs Religion - 25th Mar 17
Will Washington Risk WW3 to Block an Emerging EU-Russia Superstate - 25th Mar 17
Unaccountable Military Industrial Complex Is Destroying America and the Rest Of The World Too - 25th Mar 17
Silver Mining Stock Fundamentals - 24th Mar 17
A Walk Down the Dark Road of Bad Government - 24th Mar 17
Is Stock Market Flash Crash Postponed Until Monday? - 24th Mar 17
Stock Market Bubble and Gold - 24th Mar 17
Maps Of Past Empires That Can Tell Us About The Future - 24th Mar 17
SNP Independent Scotland's Destiny With Economic Catastrophe, the English Subsidy - IndyRef2 - 24th Mar 17
Stock Market VIX Cycles Set To Explode March/April 2017 – Part II - 23rd Mar 17
Is Now a Good Time to Invest in the US Housing Market? - 23rd Mar 17
The Stock Market Is a Present-Day Version of Pavlov’s Dog - 23rd Mar 17
US Budget - There’s Almost Nothing Left To Cut - 23rd Mar 17
Stock Market Upward Reversal Or Just Quick Rebound Before Another Leg Down? - 23rd Mar 17
Trends to Look Out For as a Modern-day Landlord - 23rd Mar 17
Here’s Why Interstate Health Insurance Won’t Fix Obamacare / Trumpcare - 23rd Mar 17
China’s Biggest Limitations Determine the Future of East Asia - 23rd Mar 17
This is About So Much More Than Trump and Brexit - 23rd Mar 17
Trump Stock Market Rally Over? 20% Bear Drop By Mid Summer? - 22nd Mar 17
Trump Added $3 Trillion in Wealth to Stock Market Participants - 22nd Mar 17
What's Next for the US Dollar, Gold and Stocks? - 22nd Mar 17
MSM Bond Market Full Nonsense Mode as ‘Trump Trades’ Unwind on Schedule - 22nd Mar 17
Peak Gold – Biggest Gold Story Not Being Reported - 22nd Mar 17
Return of Sovereign France, Europe’s Changing Landscape - 22nd Mar 17
Trump Stocks Bull Market Rolling Over? You Were Warned! - 22nd Mar 17
Stock Market Charts That Scream “This Is It” - Here’s What to Do - 22nd Mar 17
Raising the Minimum Wage Is a Jobs Killing Move - 22nd Mar 17
Potential Bottoming Patterns in Gold and Silver Precious Metals Stocks Complex... - 22nd Mar 17
UK Stagflation, Soaring Inflation CPI 2.3%, RPI 3.2%, Real 4.4% - 21st Mar 17
The Demise of the Gold and Silver Bull Run is Greatly Exaggerated - 21st Mar 17
USD Decline Continues, Pull SPX Down as well? - 21st Mar 17
Trump Watershed Budget - 21st Mar 17
How do Client Acquisition Offers Affect Businesses? - 21st Mar 17

Market Oracle FREE Newsletter

Elliott Wave Trading

Stock Market Myths, and What’s Wrong with the Economy

Stock-Markets / Stock Markets 2016 Mar 08, 2016 - 03:10 PM GMT

By: Tony_Caldaro

Stock-Markets

Stock market myths

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.

After analyzing the chart data in detail, and using OEW analysis from the years 1921 to 2015, we determined there have been 33 bull/bear markets. Seventeen bull markets and sixteen bear markets. Then after analyzing each of the bull/bear markets individually, plus allowing for earnings to top/bottom within one year of a stock market top/bottom, we found that earnings are correlated with the stock market slightly less than 58% of the time, i.e. 19 of the 33 times.

In fact, we found nine instances when the stock market and earnings moved in completely opposite directions. Seven times earnings rose throughout an entire bear market, and twice earnings declined throughout an entire bull market. Simply put, 27% of the time earnings and stock market prices move in completely opposite directions. During the remaining five periods, earnings trended up/down within the five bull/bear markets.

While reviewing all these bull/bear markets we made note of their PE multiple peaks and lows. Bull market multiples have peaked at as low as 9 in 1980, and as high as 35 in 2000, with the mean PE at 19 in 2007. Bear market multiples have bottomed as low as 6 in 1949, and as high as 23 in 2002, with the mean PE at 11 in 1957 and 1984. What was also surprising was the PE multiple at the highly acclaimed “wildly speculative” 1929 peak was an historically normal bull market PE of 20.

Another common belief is that interest rates have an effect on market price earnings ratios. So we took a look at that relationship also. We were able to start this analysis during the 1932-1937 bull market, dropping the total bull/bear markets covered to 31. What we found is that normal short term rates of 6% or less have little impact, if any, on market multiples. The only times we noticed a definite impact was during the 1978-1980 advance and the 1982-1983 advance. Rates peaked at 15.0% during 1978-1980, and that advance ended with a PE of 9. Rates peaked at 9.0% during the 1982-1983 advance, and that one ended with a PE of 13. These two advances were the only times short term rates hit over 7% during a bull market in the entire study. Normal short term rates, under 7%, have little to no impact.

Conclusions and further observations

Since corporate earnings are rising with the stock market only 50% of the time, they are not the determining factor to create and/or sustain bull markets. Investor confidence in the economy, or an individual company, along with future expectations drive bull markets. Investor sentiment is the driving force. Individual stocks can sell at multiples in the 100’s, if confidence in future growth is strong. While stocks can sell at multiples in the single digits, if confidence in future growth is lacking.

While mergers and acquisitions can make companies bigger and more cost effective. This does not directly translate into higher investor confidence. It just creates a larger company. A strong management team and consistent results are more important.

Stock buybacks, aimed at decreasing the amount of shares outstanding, which should translate into lower PE multiples and higher stock prices. Does not directly increase investor confidence either. Especially when debt is used to buy back the shares. It just creates more debt.

Laying off employees during an economic downturn, and/or a decline in revenue or gross margins, does not directly increase investor confidence. It only makes a company look cyclical. Which as noted earlier generally goes hand in hand with lower PE multiples, and a lower stock price.

In summary, M & A, stock buybacks and laying off employees, all of which are quite popular activities in recent decades, do not automatically translate into higher stock prices. They simply represent an active management team that is short term oriented. What drives up stock prices is long term planning, and consistency in meeting long term goals. This increases investor confidence, and it alone drives up stock prices. When investor confidence is high bull markets unfold, whether or not, earnings are rising or not. The same thing could apply to individual stocks, and it does at times.

The Economy

While continuing the GAAP earnings analysis we took a look at Real GDP growth during all the bull/bear market periods from the 1930’s. Overall we did not observe any direct correlation between GDP peaks and Bull market peaks. However, we did observe something interesting which confirmed our suspicions.

When we throw out the volatile 1930’s and 1940’s, created by depression rebounds and war demands, we find that Real GDP growth moved above 5% during economic expansions, and below 0% during contractions. This continued from the 1950’s until it stopped in the mid-1980’s. Since the mid-1980’s peak growth has been under 5% and getting less and less.

Data: 1984-1987 +4.2%, 1987-2000 +4.9%, 2002-2007 +3.8%, and 2009-2015 +2.5%.

The cause, and problem, is easily observed in the Federal Debt as a percentage of GDP link. In the mid-1980’s this ratio first approached, and exceeded, the 50% threshold. Since then it has continued to rise, and even the decline in 2000 held above 50%. Until the government gets debt back under control, GDP growth will continue to be weaker than it should be for a country as innovative and productive as the USA.

https://research.stlouisfed.org/fred2/series/A191RL1A225NBEA

https://research.stlouisfed.org/fred2/series/GFDEGDQ188S

CHARTS: http://stockcharts.com/public/1269446/tenpp

https://caldaro.wordpress.com

After about 40 years of investing in the markets one learns that the markets are constantly changing, not only in price, but in what drives the markets. In the 1960s, the Nifty Fifty were the leaders of the stock market. In the 1970s, stock selection using Technical Analysis was important, as the market stayed with a trading range for the entire decade. In the 1980s, the market finally broke out of it doldrums, as the DOW broke through 1100 in 1982, and launched the greatest bull market on record. 

Sharing is an important aspect of a life. Over 100 people have joined our group, from all walks of life, covering twenty three countries across the globe. It's been the most fun I have ever had in the market. Sharing uncommon knowledge, with investors. In hope of aiding them in finding their financial independence.

Copyright © 2016 Tony Caldaro - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

Tony Caldaro Archive

© 2005-2016 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Catching a Falling Financial Knife