Monday, June 17, 2019

From the Desk of David Burks – The Biggest Driver of Long-term Stock Market Performance? Corporate Profits

David Burks
Author position
Sr. Vice President | Equity Income Analyst

From the Desk of David Burks

Senior Vice President and Equity Income Analyst David Burks has been with Hilliard Lyons, A Baird Company, since 1983. David has been nationally recognized for his stock recommendations eleven times: seven times by Thomson Reuters and four by The Wall Street Journal. David has appeared regularly on CNBC over the years.

The Biggest Driver of Long-term Stock Market Performance? Corporate Profits

Each trading day we hear the financial media and their guests offer views as to what’s driving the market’s moves in that particular trading session. We realize there are many factors that can potentially affect the stock market on any given day. These could range from economic reports, corporate news and geopolitical developments to moves in interest rates, energy prices and even computer generated trading, among many possibilities. Any of these or other factors can explain most day-to-day market fluctuations. However, let’s not lose sight of what is the most important driver of long-term stock market performance: corporate earnings.

As is clearly evident in the chart above, there exists a strong long-term correlation between corporate earnings and stock prices. In this example we compare S&P 500 corporate earnings estimates to the S&P 500 index over the past 15 years. Over time we see they generally move in tandem. That was the case when the U.S. went into the severe 2007-2009 recession. It has also held true in the expansion since. Companies and investors alike have clearly benefitted from the longest expansion in US history, now 121 months long. Going forward, we anticipate that the correlation between corporate earnings and stock market performance will remain largely intact.

“Profits are the Mother’s Milk of Stocks”

One of our favorite financial commentators over the years has been Larry Kudlow. Mr. Kudlow served in the Reagan administration in the Office of Management and Budget in the 1980s. In recent years Mr. Kudlow has been a fixture on CNBC. In addition to hosting his own show, he also has appeared in much of the network’s other programming. Mr. Kudlow currently serves as President Trump’s top economic advisor. His formal title is “Director of the United States National Economic Council.” Why do we mention him here? Because one of Mr. Kudlow’s favorite sayings over the years has been, “Profits are the mother’s milk of stocks.” We agree with his view and believe that history corroborates this position. Longer term, corporate earnings are largely responsible for the stock market’s direction. When earnings rise, stocks generally rise. When earnings decline, stocks generally decline as well.

“Big Picture” Reminder

Always remember that the “stock market” is much more than just a colossal financial entity that generates either higher or lower numbers each day. Rather it’s the sum total of several thousand publicly traded businesses, each of which has its own unique fundamental outlook. When companies succeed in growing their earnings, investors are more willing to pay for increased profits. This usually results in higher stock prices. And, of course, the reverse is true. If an individual company, or all companies collectively, produce less earnings, then it’s not unreasonable to expect downward pressure on stock prices.

We understand why this discussion might appear simplistic. Yet it may be easy to overlook the correlation between earnings and stock prices due to the ongoing barrage of financial information. We encourage investors to keep a “big picture” perspective and maintain their long-term focus. Certainly stocks are volatile and will always carry inherent risk. However, we still believe stocks offer investors an opportunity to create long-term wealth through capital appreciation as businesses continue to grow and prosper over time.



Each client’s investment needs, risk tolerance, and goals are different. This newsletter is not meant to be advice for any specific investor. Nothing in it should be construed as an offer to sell, or a solicitation of an offer to buy, any securities. This should not be used as the sole basis for an investment decision. Any opinions or estimates are subject to change without notice. For information about how any of this information applies to your personal financial situation, please contact your Wealth Advisor.

Past performance is not a guarantee of future results.

Although the information provided to you in this newsletter was obtained or compiled from sources that we believe are reliable, J.J.B. Hilliard, W.L. Lyons, LLC, A Baird Company, cannot, and does not, guarantee that the information or data is accurate, timely, valid, or complete.

All investing involves risk, including the possible loss of principal. You should carefully consider investment objectives, risks, charges, and expenses of any investment before investing. Diversification and asset allocation do not guarantee a profit or guarantee against a loss. Note: It is not possible to invest directly in an index.

Stock markets, especially foreign markets, are volatile and can decline significantly in response to adverse issuer, political, regulatory, market or economic developments. The bond market is also volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect can be more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks.