≈ Earnings. ≈

Traders,

There are two ways to explain market growth. It either comes from earnings growth or multiple expansion. In the former case, valuations either hold steady or shrink. In the latter case, valuations increase. That is, stocks get more expensive.

Let’s say the market P/E ratio was 20. If the S&P 500 rises 10% over the next year, but earnings also rise 10%, then the P/E ratio would remain at 20. That’s an example of the stock market’s gain being driven by profits.

Now, let’s take the same situation but assume earnings didn’t grow at all. If the S&P 500 climbs 10% over the next year without any accompanying jump in earnings, then the P/E ratio would rise to 22 – signaling stocks are now more expensive. This is known as multiple expansion because stocks are currently trading at a higher multiple (22x earnings) than they used to be.

Both potential fuels are not created equal. Earnings growth is far more potent. I’ll repeat it for emphasis – it allows stocks to rise without getting any more expensive! And that, in turn, means the market’s climb is more sustainable. It was built on a sure foundation, not just hope or hype.

The chart of the day reveals which of the two is behind this year’s bull run.

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Chart of the Day

Earnings is Fueling the Rise

The market is 20% higher right now than at the end of last year. But it’s not 20% more expensive. Earnings growth has seen to that.

Video of the day

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