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Chart of the week

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.

  • S&P 500 Index.

  • FactSet, https://bit.ly/2ENDClO.

  • Data from Charles Schwab via Ned Davis Research, as of April 19, 2018.

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