6 charts that help explain why stocks are going up 📈
6 charts that help explain why stocks are going up 📈
Plus a charted review of the macro crosscurrents 🔀
📈 Stocks rallied to new all-time highs, with the S&P 500 setting a record intraday high of 5,447.25 on Wednesday and a record closing high of 5,433.74 on Thursday. For the week, the S&P gained 1.6% to end at 5431.60. The index is now up 13.9% year to date and up 51.8% from its October 12, 2022 closing low of 3,577.03.
-
Earlier this month, we talked about how bull markets tend to last much longer and generate much stronger returns than the one we continue to experience.
But prices don’t go up for the sake of going up.
They go up because earnings are going up.
Sure, oftentimes prices may decouple from fundamentals (i.e., a company’s ability to make money) over short-term periods — which is why market-timing is so difficult.
But many analysts argue that’s not what’s going on right now. They’ll argue that prices are up because the fundamentals are favorable.
Here’s a sampling of what Wall Street’s top stock market pros of pointed out in recent weeks:
Cash flow generation is strong 💰
One of the more repeated concerns in the stock market is that valuations are elevated above their long-term averages.
UBS’s Jonathan Golub argues today’s historically high valuations are justified.
“S&P 500 companies have been generating more cash flow over the past 3 decades, justifying higher valuations,“ Golub wrote on Monday.
For more on valuations, read: The problem with historical P/E data 📜
Resilient profit margins are amplifying earnings growth 💸
With the economy cooling, sales growth isn’t as hot as it used to be. But that hasn’t had too much of an impact on earnings growth.
“[W]e think it's important to point out that S&P 500 trailing earnings growth is turning higher (now 4% Y/Y up from -1% to start the year),” Morgan Stanley’s Michael Wilson observed on Monday. “Margin improvement is fueling this rise in earnings growth as top line growth has remained steady throughout the year.”
For more on margins, read: Profit margins are holding up 💰
Earnings are driving stock prices 🤑
Expanding valuations were a large driver of stock market returns over the past year.
More recent gains appear to be driven by earnings.
“Good news - the baton seems to be being passed from valuation to earnings,” Fidelity’s Jurrien Timmer wrote on Wednesday. “This is exactly what is needed to sustain the cyclical bull market. Per the weekly chart below, the year-over-year change in the trailing P/E ratio has slowed from +30% to +15%, while the year-over-year change in trailing earnings has accelerated from -2% to +6%.“
Fundamentals suggest it’s not a tech bubble 🫧
The megacap tech names have drawn a lot of attention as they’ve been responsible for much of the stock market’s gains in recent years. But their outperformance is supported by outsized earnings growth, which makes the current run up in prices very different from the dotcom bubble.
“As asset bubbles form, a key reason volatility rises is that stocks start trading purely on momentum, decoupling from their fundamental tether (where fundamentals exist),” BofA’s Benjamin Bowler wrote. “Exhibit 20 shows how this tether was broken in the Nasdaq in 1998-2000 (vs the S&P), in contrast to how closely linked fundamentals & tech stock prices appear today.”
For more on megacap tech fundamentals, read: The biggest stocks in the market are massive for a reason 💪
Increased market concentration isn’t a sign of trouble 📜
As we’ve discussed, market concentration in itself is not a reason to be too concerned about the market.
Global Financial Data (GFD) has a great post exploring market concentration going all the way back to 1790. High market concentration is not a new phenomenon.
“Based upon our analysis of the past 150 years, there seems no reason to believe that the increased concentration of the past ten years is the harbinger of a major bear market,” GFD’s Bryan Taylor wrote (HT Abnormal Returns). “Increased concentration is the sign of a bull market and bear markets reduce concentration.“
For more on market concentration, read: All stocks are not created equal ⚖️
Earnings growth is broadening out 🙌
Yes, it is the case that the megacap tech names have been responsible for much of the earnings growth in the market. But that narrative is shifting.
“Perhaps the most important near-term support for the stock market is the ongoing acceleration of corporate earnings,” Richard Bernstein Advisors’ Dan Suzuki wrote on Wednesday. “Earnings growth has been accelerating since the end of 2022, and we forecast further acceleration over the next several quarters. Not only is growth accelerating, but critically, it’s also broadening out.”
For more on earnings broadening out, read: The magnificent earnings story is shifting 🔀
The bottom line 💰
The “bottom line” is an idiom that’s often used as a metaphor to characterize “the essential or salient point.“
The term actually comes from accounting. On an income statement, the top line is revenue. As you move down the income statement, you see costs, expenses, interest, taxes, and other items, all of which you subtract from revenue. And what you’re left with is the bottom line: earnings.
As we’ve seen in the charts above, analysts agree the prospects for earnings are looking favorable for stocks.
And in the stock market, earnings are the most important driver of prices in the long run.
That is to say: The bottom line is the bottom line.
-
Related from TKer:
4 key observations about the U.S. stock market to remember 📊
Peter Lynch made a remarkably prescient market observation in 1994 🎯
Smart people agree that the best investing wisdom shares a common theme 🧐
Where Wall Street's year-end price target calculations often go wrong 😑
Goldman Sachs raises its target for the S&P 500 📈
On Friday, Goldman Sachs’ David Kostin raised his year-end target for the S&P 500 to 5,600 from 5,200. This is his third revision from his initial target.
“Our 2024 and 2025 earnings estimates remain unchanged but stellar earnings growth by five mega-cap tech stocks have offset the typical pattern of negative revisions to consensus EPS estimates,” Kostin wrote. “We expect roughly unchanged real yields by year-end and strong earnings growth will support a 15x P/E for the equal-weight S&P 500 and a 36% premium multiple for the market-cap index.”
Kostin is not alone in tweaking his forecasts. His peers at UBS, Morgan Stanley, Deutsche Bank, BMO, CFRA, Oppenheimer, RBC, Societe Generale, BofA, and Barclays are among those who’ve also raised their targets.
Don’t be surprised to see more of these revisions as the S&P 500’s performance, so far, has exceeded many strategists’ expectations.
Reviewing the macro crosscurrents 🔀
There were a few notable data points and macroeconomic developments from last week to consider:
🏛️ The Fed holds steady. The Federal Reserve announced it would keep its benchmark interest rate target high at a range of 5.25% to 5.5%.
From the Fed’s statement (emphasis added): “Recent indicators suggest that economic activity has continued to expand at a solid pace. Job gains have remained strong, and the unemployment rate has remained low. Inflation has eased over the past year but remains elevated. In recent months, there has been modest further progress toward the Committee's 2% inflation objective.”
The central bank’s new “dot plots” imply fewer rate cuts in 2024 and 2025 than what it previously forecast after the Fed’s March meeting.
Basically, the Fed will keep monetary policy tight until inflation rates cool further. That means the odds of a rate cut in the near term will remain low.
For more context, read: There's a more important force than the Fed driving the stock market 💪 and Whether or not the Fed cuts rates is not the right question 🔪
🎈 Inflation cools. The Consumer Price Index (CPI) in May was up 3.3% from a year ago, down from the 3.4% rate in April. Adjusted for food and energy prices, core CPI was up 3.4%, down from the 3.6% rate in the prior month. This was the lowest increase in core CPI since April 2021.
On a month-over-month basis, CPI was unchanged as energy prices fell 2%. Core CPI increased by 0.2%.
If you annualize the three-month trend in the monthly figures — a reflection of the short-term trend in prices — CPI was rising at a 2.8% rate and core CPI was climbing at a 3.3% rate.
Overall, while many broad measures of inflation continue to hover above the Fed’s target rate of 2%, they are way down from peak levels in the summer of 2022.
For more, read: Inflation: Is the worst behind us? 🎈
🤷🏻♂️ Inflation expectations were mixed. From the New York Fed’s May Survey of Consumer Expectations: “Median inflation expectations at the one-year horizon declined to 3.2% in May from 3.3% in April, were unchanged at the three-year horizon at 2.8%, and increased at the five-year horizon to 3.0% from 2.8%.”
For more, read: The end of the inflation crisis 🎈
⛽️ Gas prices fall. From AAA: “Another week, another slide in gas prices as the national average for a gallon of gasoline dipped two cents since last Thursday to $3.46. The main reasons for the decline are lackluster gasoline demand and burgeoning supply. … According to new data from the Energy Information Administration (EIA), gas demand crept higher from 8.94 million b/d to 9.04 last week. Meanwhile, total domestic gasoline stocks jumped from 230.9 to 233.5 million barrels as production increased last week, averaging 10.1 million barrels per day. Mediocre gasoline demand, increasing supply, and stable oil costs will likely lead to falling pump prices.”
For more on energy prices, read: Higher oil prices meant something different in the past 🛢️
🏠 Mortgage rates tick lower. According to Freddie Mac, the average 30-year fixed-rate mortgage declined to 6.95% from 6.99% the week prior. From Freddie Mac: “Mortgage rates continued to fall back this week as incoming data suggests the economy is cooling to a more sustainable level of growth. Top-line inflation numbers were flat but shelter inflation, which measures rent and homeownership costs, increased showing that housing affordability continues to be an ongoing impediment for buyers on the house hunt.”
There are 146 million housing units in the U.S., of which 86 million are owner-occupied. 39% are mortgage-free. Of those carrying mortgage debt, almost all have fixed-rate mortgages, and most of those mortgages have rates that were locked in before rates surged. All of this is to say: Most homeowners are not particularly sensitive to movements in home prices or mortgage rates.
For more on mortgages and home prices, read: Why home prices and rents are creating all sorts of confusion about inflation 😖
💼 Unemployment claims tick higher. Initial claims for unemployment benefits rose to 242,000 during the week ending June 8, up from 229,000 the week prior. This was the highest print since August 2023. While this is above the September 2022 low of 187,000, it continues to trend at levels historically associated with economic growth.
For more, read: Labor market: How cool will it get? 🥶
👎 Sentiment deteriorates. From the University of Michigan’s June Surveys of Consumers: “Consumer sentiment was little changed in June; this month’s reading was a statistically insignificant 3.5 index points below May and within the margin of error. Sentiment is currently about 31% above the trough seen in June 2022 amid the escalation in inflation. Assessments of personal finances dipped, due to modestly rising concerns over high prices as well as weakening incomes. Overall, consumers perceive few changes in the economy from May.“
Weak consumer sentiment readings appear to contradict resilient consumer spending data. For more on this contradiction, read: What consumers do > what consumers say 🙊
💳 Card spending is holding up. From JPMorgan: “As of 07 Jun 2024, our Chase Consumer Card spending data (unadjusted) was 1.7% below the same day last year. Based on the Chase Consumer Card data through 07 Jun 2024, our estimate of the US Census May control measure of retail sales m/m is 0.67%.“
From Bank of America: “Total card spending per HH was up 1.6% y/y in the week ending Jun 8, according to BAC aggregated credit & debit card data. Retail ex auto spending per HH came in at 0.4% y/y in the week ending Jun 8. Card spending appears to be off to a solid start in June.”
For more on consumer finances, read: Unsettling stats about consumer health are missing the bigger picture 💵
👍 Small business optimism improves. The NFIB’s Small Business Optimism Index ticked higher in May.
Importantly, the more tangible “hard” components of the index continue to hold up much better than the more sentiment-oriented “soft” components.
Keep in mind that during times of perceived stress, soft data tends to be more exaggerated than actual hard data.
For more on this, read: What businesses do > what businesses say 🙊 and Sentiment: Finally a vibe-spansion? 🙃
📈 Near-term GDP growth estimates look good. The Atlanta Fed’s GDPNow model sees real GDP growth climbing at a 3.1% rate in Q2.
For more on economic growth, read: Economic growth: Slowdown, recession, or something else? 🇺🇸
Putting it all together 🤔
We continue to get evidence that we are experiencing a bullish “Goldilocks” soft landing scenario where inflation cools to manageable levels without the economy having to sink into recession.
This comes as the Federal Reserve continues to employ very tight monetary policy in its ongoing effort to get inflation under control. While it’s true that the Fed has taken a less hawkish tone in 2023 and 2024 than in 2022, and that most economists agree that the final interest rate hike of the cycle has either already happened, inflation still has to stay cool for a little while before the central bank is comfortable with price stability.
So we should expect the central bank to keep monetary policy tight, which means we should be prepared for relatively tight financial conditions (e.g., higher interest rates, tighter lending standards, and lower stock valuations) to linger. All this means monetary policy will be unfriendly to markets for the time being, and the risk the economy slips into a recession will be relatively elevated.
At the same time, we also know that stocks are discounting mechanisms — meaning that prices will have bottomed before the Fed signals a major dovish turn in monetary policy.
Also, it’s important to remember that while recession risks may be elevated, consumers are coming from a very strong financial position. Unemployed people are getting jobs, and those with jobs are getting raises.
Similarly, business finances are healthy as many corporations locked in low interest rates on their debt in recent years. Even as the threat of higher debt servicing costs looms, elevated profit margins give corporations room to absorb higher costs.
At this point, any downturn is unlikely to turn into economic calamity given that the financial health of consumers and businesses remains very strong.
And as always, long-term investors should remember that recessions and bear markets are just part of the deal when you enter the stock market with the aim of generating long-term returns. While markets have recently had some bumpy years, the long-run outlook for stocks remains positive.
For more on how the macro story is evolving, check out the the previous TKer macro crosscurrents »
TKer’s best insights about the stock market 📈
Here’s a roundup of some of TKer’s most talked-about paid and free newsletters about the stock market. All of the headlines are hyperlinked to the archived pieces.
10 truths about the stock market 📈
The stock market can be an intimidating place: It’s real money on the line, there’s an overwhelming amount of information, and people have lost fortunes in it very quickly. But it’s also a place where thoughtful investors have long accumulated a lot of wealth. The primary difference between those two outlooks is related to misconceptions about the stock market that can lead people to make poor investment decisions.
The makeup of the S&P 500 is constantly changing 🔀
Passive investing is a concept usually associated with buying and holding a fund that tracks an index. And no passive investment strategy has attracted as much attention as buying an S&P 500 index fund. However, the S&P 500 — an index of 500 of the largest U.S. companies — is anything but a static set of 500 stocks.
The key driver of stock prices: Earnings💰
For investors, anything you can ever learn about a company matters only if it also tells you something about earnings. That’s because long-term moves in a stock can ultimately be explained by the underlying company’s earnings, expectations for earnings, and uncertainty about those expectations for earnings. Over time, the relationship between stock prices and earnings have a very tight statistical relationship.
Stomach-churning stock market sell-offs are normal🎢
Investors should always be mentally prepared for some big sell-offs in the stock market. It’s part of the deal when you invest in an asset class that is sensitive to the constant flow of good and bad news. Since 1950, the S&P 500 has seen an average annual max drawdown (i.e., the biggest intra-year sell-off) of 14%.
High and rising interest rates don't spell doom for stocks👍
Generally speaking, rising interest rates are not welcome news for the economy and the stock market. They represent higher financing costs for businesses and consumers. All other things being equal, rising rates represent a hindrance to growth. However, the world is complicated, and this narrative comes with a lot of nuance. One big counterintuitive piece to this narrative is that historically, stocks have actually performed well during periods of rising interest rates.
How stocks performed when the yield curve inverted ⚠️
There’ve been lots of talk about the “yield curve inversion,” with media outlets playing up that this bond market phenomenon may be signaling a recession. Admittedly, yield curve inversions have a pretty good track record of being followed by recessions, and recessions usually come with significant market sell-offs. But experts also caution against concluding that inverted yield curves are bulletproof leading indicators.
How the stock market performed around recessions 📉📈
Every recession in history was different. And the range of stock performance around them varied greatly. There are two things worth noting. First, recessions have always been accompanied by a significant drawdown in stock prices. Second, the stock market bottomed and inflected upward long before recessions ended.
In the stock market, time pays ⏳
Since 1928, the S&P 500 generated a positive total return more than 89% of the time over all five-year periods. Those are pretty good odds. When you extend the timeframe to 20 years, you’ll see that there’s never been a period where the S&P 500 didn’t generate a positive return.
What a strong dollar means for stocks 👑
While a strong dollar may be great news for Americans vacationing abroad and U.S. businesses importing goods from overseas, it’s a headwind for multinational U.S.-based corporations doing business in non-U.S. markets.
Economy ≠ Stock Market 🤷♂️
The stock market sorta reflects the economy. But also, not really. The S&P 500 is more about the manufacture and sale of goods. U.S. GDP is more about providing services.
Stanley Druckenmiller's No. 1 piece of advice for novice investors 🧐
…you don't want to buy them when earnings are great, because what are they doing when their earnings are great? They go out and expand capacity. Three or four years later, there's overcapacity and they're losing money. What about when they're losing money? Well, then they’ve stopped building capacity. So three or four years later, capacity will have shrunk and their profit margins will be way up. So, you always have to sort of imagine the world the way it's going to be in 18 to 24 months as opposed to now. If you buy it now, you're buying into every single fad every single moment. Whereas if you envision the future, you're trying to imagine how that might be reflected differently in security prices.
Peter Lynch made a remarkably prescient market observation in 1994 🎯
Some event will come out of left field, and the market will go down, or the market will go up. Volatility will occur. Markets will continue to have these ups and downs. … Basic corporate profits have grown about 8% a year historically. So, corporate profits double about every nine years. The stock market ought to double about every nine years… The next 500 points, the next 600 points — I don’t know which way they’ll go… They’ll double again in eight or nine years after that. Because profits go up 8% a year, and stocks will follow. That's all there is to it.
Warren Buffett's 'fourth law of motion' 📉
Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the stars, but not the madness of men.” If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.
Most pros can’t beat the market 🥊
According to S&P Dow Jones Indices (SPDJI), 59.7% of U.S. large-cap equity fund managers underperformed the S&P 500 in 2023. As you stretch the time horizon, the numbers get even more dismal. Over a three-year period, 79.8% underperformed. Over a 10-year period, 87.4% underperformed. And over a 20-year period, 93% underperformed. This 2023 performance follows 13 consecutive years in which the majority of fund managers in this category have lagged the index.
Proof that 'past performance is no guarantee of future results' 📊
S&P Dow Jones Indices found that funds beat their benchmark in a given year are rarely able to continue outperforming in subsequent years. For example, 334 large-cap equity funds were in the top half of performance in 2021. Of those funds, 58.7% came in the top half again in 2022. But just 6.9% were able to extend that streak through 2023. If you set the bar even higher and consider those in the top quartile of performance, just 20.1% of 164 large-cap funds remained in the top quartile in 2022. No large-cap funds were able to stay in the top quartile for the three consecutive years ending in 2023.
The odds are stacked against stock pickers 🎲
Picking stocks in an attempt to beat market averages is an incredibly challenging and sometimes money-losing effort. In fact, most professional stock pickers aren’t able to do this on a consistent basis. One of the reasons for this is that most stocks don’t deliver above-average returns. According to S&P Dow Jones Indices, only 24% of the stocks in the S&P 500 outperformed the average stock’s return from 2000 to 2022. Over this period, the average return on an S&P 500 stock was 390%, while the median stock rose by just 93%.
