Earnings and Subsequent Market Performance

Thursday, April 27, 2006 | 06:54 AM

Someone on Kudlow's show misquoted me on Monday (Larry?), and I wanted to get this specific data correct and distributed.

The year-over-year earnings indicator is based on the work of Marty Zweig; Its something I have mentioned for several years now, and it has proven to be an accurate and reliable tell. Its based on data since 1927, and includes the great crash, as well as recent bull markets.

Specifically, double digit earnings growth are not a Sell Signal. What they have historically signified, however, was a future period of market underperformance.

Nor are really awful earnings a buy signal. Very bad numbers lead to major market losses.

Market Performance
Let's start out assuming an average SPX return of about 11%; we can make that number higher or lower depending upon which time periods we use, whether we reinvest dividends, etc., but for this illustration, lets work with 11% as out average annual market return.

Next, we breakdown earnings returns into 5 separate groups of Year over year percentage gains or losses. They are:

Gains Above 20%

Gains between +10 and 20%

Flat +/-10%  (between losses of10% and gains of 10%)

Losses between -10% - 25%

Losses worse than 25%

Let's review these:

The best year-over-year earnings gains of over 20% produce only mediocre subsequent market performance -- over the next 12 months, S&P 500 gains on average a mere 1.9%. Rather underwhelming. It is not a sell signal, but it does suggest that other asset classes might be preferable.

Conversely, when earnings are at their worst -- when they fall 25% or more -- subsequent market performance is the worst of the group. Markets are down nearly 30% over the ensuing 12 months. Ouch.

When earnings are between 10% and 20% -- where we are today -- the subsequent market gains are positive, but are  historically mediocre -- about 5.8% over the next 12 months. Compare that with the risk free 10-year Yield of 5.1%, and again, you can see why this is underwhelming.

The remaining two groupings produce good, and excellent returns: When earnings are plus or minus 10% from flat year-over-year, we get subsequent returns of 9.3%. That's pretty close to our historical average. One would expect these types of gains in the early to mid part of the business cycle.

The best market performance is in a negative range: down 25% to down 10% earnings; Subsequent market gains are a fabulous 28.6%.

I never like to rely on a single variable, and my work with the present cycle of P/E multiple contraction implies that we may be looking at numbers somewhat below thes average market performance.

Hence, why I am so unenthused by double digit year over year earnings gains.   

Why Do Earnings Gains Forecast Market Performance?

My explanation for this is simple: Earnings reveal where we are in the broader market cycle, and also provide some insight into market psychology. I hope to have more on this issue soon . . .


Here's the same info, in chart form:




Sources/Prior References:

The Sweet Spot ?       

How to Use Earnings as a Buy Signal                     

Earnings and Subsequent Market Gains                      

Earnings or Multiple Expansion?                

Single vs. Multiple Variable Analysis in Market Forecasts            

Thursday, April 27, 2006 | 06:54 AM | Permalink | Comments (5) | TrackBack (1)
de.li.cious add to de.li.cious | digg digg this! | technorati add to technorati | email email this post



TrackBack URL for this entry:

Listed below are links to weblogs that reference Earnings and Subsequent Market Performance:

» links for 2006-04-28 from Reasoned Investing
Earnings and Subsequent Market Performance Ritholtz lays out one method of how earnings can be used to forecast market performance (tags: Earnings Forecast MarketHistory)... [Read More]

Tracked on Apr 28, 2006 12:20:29 AM


Historically, one of the most dangerous times for the market is right after the y/y Ch. in eps growth turns postive. A prime example of this is 1987.

Posted by: spencer | Apr 27, 2006 8:06:06 AM

The comments to this entry are closed.

Recent Posts

December 2008
Sun Mon Tue Wed Thu Fri Sat
  1 2 3 4 5 6
7 8 9 10 11 12 13
14 15 16 17 18 19 20
21 22 23 24 25 26 27
28 29 30 31      


Complete Archives List



Category Cloud

On the Nightstand

On the Nightstand

 Subscribe in a reader

Get The Big Picture!
Enter your email address:

Read our privacy policy

Essays & Effluvia

The Apprenticed Investor

Apprenticed Investor

About Me

About Me
email me

Favorite Posts

Tools and Feeds

AddThis Social Bookmark Button

Add to Google Reader or Homepage

Subscribe to The Big Picture

Powered by FeedBurner

Add to Technorati Favorites


My Wishlist

Worth Perusing

Worth Perusing

mp3s Spinning

MP3s Spinning

My Photo



Odds & Ends

Site by Moxie Design Studios™