The Real Reason The Stock Market Is Down
P/E multiple contraction is the main driver of falling share prices.
On average over the past century, according to an analysis conducted by Ned Davis Research, the S&P 500 has performed better when its EPS was lower than a year previously — not higher.
The S&P 500’s best quarterly returns in the past have come when its trailing four-quarter EPS were between 20% lower and 5% higher than where they were one year prior.
With the exception of quarters in which EPS was more than 20% lower than a year earlier, there’s an inverse relationship between EPS growth and the S&P 500’s performance.
Even with companies’ recent reduced earnings projections, Standard & Poor’s estimates that the stock market’s trailing four-quarter EPS as of June 30 will be 28% higher than the comparable total on June 30, 2021.
Over the past year, the U.S. stock market’s P/E multiple (based on trailing 12 months’ GAAP EPS) has fallen to below 20 from more than 30. Had the multiple remained constant, the S&P 500 today would be 28% higher than a year ago. In fact, it is 6% lower.
So if earnings aren’t going down, then the P/E multiple is to blame which means there are some companies out there with strong earnings that you could pick up at a real bargain in this environment.
Until next time,
Paul Cerro | Cedar Grove Capital
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