S&P Earnings Now Vs. 2007, Prior To The Collapse Of Stocks

by: The Capitalist Manifesto

I keep hearing that another 2000 or 2008 won't be happening. Again, not being Debbie Downer or Negative Nelly, I am just trying to take in the actual data and see why it may be different this time.

Stocks are driven, over the long run, by earnings and sales, as they should be. Earnings and sales will yield better cash flow and better balance sheets, which in turn will lead to growth of stocks.

In 2007, the market was experiencing a massive overvaluation, and many just thought it was the banking industry that brought down the market, which it was not. It was a factor for sure, but the excess caused by banking is what caused the stocks to reach such high levels.

As you see below, in 2007/2008, the market was at very high valuation levels as measured by the stock market to GDP ratio, which is 92% reliable historically, according to John Hussman.

As you can see, we are a bit more overvalued than they are today, but projected returns were still very dismal back then for the 10-year potential return, and guess what, the "improbable" happened. It wasn't really improbable. It is just like today. Everyone thinks it can't happen because stocks were in the middle of a four-year bull market in 2007.

So, what has caused the market to be 33% higher than it was in 2007 and grow 200%+ since the bottom of 2009? Let's look at earnings, sales, and the U.S. GDP. The point of this exercise is to show that in an overvalued market of 2007 that saw stocks drop almost 60%, we haven't made much more headway in terms of fundamentals.

S&P 500 Earnings (numbers are inflation adjusted to today)

In June of 2007, the S&P had hit its record earnings to date by earning $97 or so per share. So what happened afterwards on S&P's earnings from then until now? After all the losses and the recession, earnings dropped all the way down to $8 per share, a drop of 90%+ by April 2009, and then started its climb back up, reaching a peak of $106 per share in September of 2014, over one year ago. So at $97 per share and the S&P at 1,520 +/-, the market was overpriced at near record levels and now we are 39% higher (2,112 on the S&P) and earnings only increased 9% or so, how can we justify that from an earnings perspective?

Not only that, in 2007, the S&P 500 companies had a total of $6.4 trillion in debt, and currently, S&P 500 companies have $7.3 trillion of long-term debt on their books. Obviously, right now, they have more debt, but the cost to borrow has plummeted. The 10-year treasury in 2007 was around 5%, and now, the rate has been in the low 2% range, which is a drop of 60% in interest costs. Five percent on $6.4 trillion vs. 2% on $7.3 trillion is a savings of almost $180 billion. So our higher earnings now on the S&P 500 are skewed just from below normal interest costs.

S&P 500 Sales (numbers are inflation adjusted to today)

In 2007, S&P 500 had sales of $9.08 trillion amongst the 500 companies, and this year, total sales are $10.9 trillion. Definitely an increase, but only an increase of 20%, which is nice, but it's only an increase of 3% per year and doesn't justify a 33% increase in S&P 500 levels when coming from near historic high levels of valuation. If this was 1982 and valuations were at historical lows, I would be fine with stocks going so high even though revenue growth hasn't matched it because there were such undervalued levels for such an extended period of time that a point of catch-up has to occur.

GDP (numbers are inflation adjusted to today)

As I always talk about, the stock market to GDP is considered to be the single most reliable snapshot of where the stock market stands at any given point in relation to valuations.

In 2007, the U.S. had a GDP of $15 trillion and 2014 had a GDP of $16.3 trillion, which is an increase of 8.7%. Again, I won't even start talking about the amounts of government stimulus it took to cause that increase, but it's still not as high an increase as the price in the S&P 500. Not even close. And so we went from overpriced market to overpriced market. We saw a 38% increase in S&P 500 value, yet all the major factors that determine long-term value are up minor amounts, mostly driven by lower interest rates and government stimulus.


So, even if the market was fairly valued in 2007, the current price would still be considered overpriced based on what has happened on earnings, sales, and GDP since then. And we can all see from the graph above about market to GDP that 2007 was one of the highest points in history of valuation levels based on future 10-year returns.