Earnings Season Warning: It's Not Only Stock Market Valuations That Are Inflated!

Atle Willems, CFA profile picture
Atle Willems, CFA


  • Monetary expansion helps inflate both stock market valuations and earnings.
  • Inflated earnings dependent on an acceleration in the money supply growth rate is not however sustainable.
  • Earnings will therefore be negatively affected when monetary inflation decelerates.
  • Consequently, stock market valuations and earnings will both likely drop bringing about an even larger drop in stock market prices.

I discussed in a recent article a plausible reason why the bull market in stocks have lasted so long. (See A Plausible Reason For The Longevity Of The Bull Market In U.S. Stocks.) In essence, I argue low levels of investments have softened the business cycle and made possible a steady and significant expansion of the money supply combined with a prolonged period of historically low interest rates. These developments have been very positive for stock prices as the chart below indicates (which compares a broad U.S. stock market index with the money supply divided by corporate bond yields).

Stock prices benefit indirectly from an increased rate of monetary expansion since earnings will likely increase while discount rates will tend to decline, and directly as the demand for stocks tend to outpace supply. (I explain in detail how monetary inflation affects earnings, discount rates, and stock prices in Money Cycles - The Curse of an Elastic Money Supply.) Increased monetary inflation combined with lower interest rates also tend to make investors more bullish (and desperate for yield) which tend to channel yet more money into the stock market.

Since the financial results reported by companies are stated in monetary terms (price in US$ * quantity), the results are not only determined by the actual physical output sold and input used, but also on the purchasing power of the reporting currency. In a progressing economy - an economy where physical output increases over time - an inflating money supply allows prices to increase (or fall less than otherwise) in tandem with increased output. This would be impossible if the money supply were static as prices would then have to come down for the market to clear.

With the elastic currencies employed today, both revenues and costs stated in money terms will tend

This article was written by

Atle Willems, CFA profile picture
Atle Willems, author of "Money Cycles", is an analyst with Liabridge Economic Research. He holds a masters degree in finance with distinction from Nottingham University Business School and a BSc in Business Administration from Drake University.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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