Earnings Deceleration: Who Cares?

by: Justin Bynum

Unless I want to catch the highlights of the previous evening's Heels game, I wake up to CNBC to check out the AM futures. Yesterday, I caught some talking head dithering on and on about how a hiccup in earnings growth couldn't possibly derail the five-years-and-counting bull market we've experienced.Truthfully, I have no idea what will derail any bull market (or bear market for that matter), and a correct macro direction call is almost always luck (paging Bob Prechter). What I do take issue with - other than the hubris of self-anointed market psychics - is the idea that earnings growth has anything to do with anything for the stock market as a whole. Now, earnings and sales growth do have A LOT to do with individual stocks, but the entire stock market? Not so much. Anecdotally, earnings were growing very rapidly during the Stagflation of the early 1970s, yet the stock market grew handsomely while experiencing negative earnings growth later in the decade.

But, we don't make market decisions based on anecdotes, so let's go to the tape. Below are three charts expressing the relationship between earnings changes and changes in the stock market. Don't get too worked up when you see those r squareds (click on all charts to enlarge):

Here's the takeaway: Trailing earnings growth doesn't say anything about future returns for the entire stock market. Again, trailing earnings growth is very important to individual stocks, but as highlighted in a previous post, earnings don't play as big of a role as people think they do in determining market direction.

Seeing a lot of these guys on television, I often wonder if any of them have ever cracked a statistics book in their lives. Based on what comes out of some of these jokers' mouths, I bet I'd get a higher r squared with higher coefficients stating that what I had for dinner impacts the stock market more than the crap they're peddling.