Strong earnings growth a potential yellow light to the markets?
S&P 500 Index annual returns based on prior year’s earnings growth
April 20, 2018 | 1 minute minute read
U.S. stocks moved higher this week as investors shifted their focus to the first quarter’s earnings season.1 Earnings expectations are high for this quarter, with the majority of S&P 500 companies reporting in the coming weeks.
According to FactSet, S&P 500 companies will likely report earnings growth “of about 20%” for the first quarter of 2018.2 If earnings indeed come in as strong as expected, it would mark the index’s highest annual earnings growth since the third quarter of 2010.2
It also could be a potential inflection point for investors as stock market returns have generally been lackluster following periods of strong earnings growth.3
As the chart highlights, the S&P 500 Index has historically returned just 2.6% the year after the companies that comprise the index report earnings growth of 20% of more.3 The index has generally generated stronger annual returns the year after companies report less impressive earnings.3
One likely reason for the disconnect between earnings growth and investment returns is simply that markets are forward-looking. Investors often believe that companies have peaked when they’ve achieved earnings growth of 20% or higher.
We’ve noted in the past that, over the long run, corporate earnings growth can’t outpace the economy in which the companies operate. Given the current slow-growth economy, investors may be well served by preparing their portfolios for a potential environment featuring lower earnings growth and more limited investment returns.