Thursday, January 19, 2023
Investors often talk about how earnings drive stock prices. But that begs the question how so many strategists and pundits expect earnings to fall in 2023 and stocks to rise? That’s our view in LPL Research.
Let’s look at the histories of earnings growth and price performance for the S&P 500 Index on a scatterplot graph to see how often this dynamic has occurred. The LPL Chart of the Day below shows S&P 500 performance on the vertical axis and S&P 500 earnings growth on the horizontal axis.
You can see in the chart that in years when earnings fall, found on the left side of the graph, stocks are actually more likely to rise than fall (more dots are in the upper left quadrant than in the lower left one). This may be surprising to many of you, but when earnings fall, stocks are more than twice as likely to rise as they are to fall.
Some of the earnings declines were so marginal, and so long ago, that you could argue the odds of gains for stocks, if earnings drop this year, are potentially three to one (stocks have been up 71% of all years since 1950). Since 1970, of the 12 years that saw earnings declines, just 4 were accompanied by falling stock prices: 1990, 2001, 2008, and 2015—and in 2015, earnings and stocks both fell just 1%.
This may seem counterintuitive, but it makes sense when we remind ourselves that markets are forward looking. The markets generally price in earnings declines well before they happen—maybe two or three quarters ahead. By the time earnings declines are in the books, stocks have move higher in anticipation of the next earnings upcycle.
This is similar to the explanation for why stocks have historically been little changed, on average, during recessions. It’s because the big declines tend to come before the recession occurs, in anticipation of the downturn. That is essentially what stocks were doing in 2022—pricing in a downturn in 2023 from Federal Reserve over-tightening.
The lesson here seems clear. Despite a likely slight earnings decline in 2023—at least that’s our view in LPL Research—we expect a solidly positive year for stocks (our thoughts on earnings season here). That doesn’t mean the S&P 500 won’t retest the October lows in the short term—about 9% below current levels—before the next bull market gets underway. But the LPL Research Strategic and Tactical Asset Allocation Committee (STAAC) believes the risk-reward trade-off this year is positive enough right now to support an overweight equities recommendation. Our year-end S&P 500 fair value target range of 4,400-4,500 is based on a price-to-earnings ratio of 18–19 and a $240 forecast for S&P 500 earnings per share in 2024.
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments. For more information on the risks associated with the strategies and product types discussed please visit https://lplresearch.com/Risks
References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.
Unless otherwise stated LPL Financial and the third party persons and firms mentioned are not affiliates of each other and make no representation with respect to each other. Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services.
All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.
Securities and advisory services offered through LPL Financial, a registered investment advisor and broker-dealer. Member FINRA/SIPC.
Tracking # 1-05355851