Stocks Have Their Best Years When These Two Things Happen

Stocks Have Their Best Years When These Two Things Happen
Stéphane Renevier, CFA

10 days ago2 mins

Top investors don’t chase headlines: they rely on rigorous, data-driven methodologies to predict market trends. By understanding which factors drive asset prices and the assumptions underpinning these factors, they can come up with an informed, reasoned prediction of what may happen next. So can you.

A useful way to forecast future stock returns is to break them down into their two main drivers: changes in valuations (vertical axis) and changes in earnings estimates (horizontal axis).

As you can see in the chart, significant gains – like the ones we saw in 1989, 1995, 1997, 2003, and 2013 – often coincide with a robust uptick in both. But valuations appear to have the heftier influence: periods with strong valuation growth almost always ended with big returns, but there were plenty of instances where strong earnings growth wasn’t capped by strong returns.

That’s why this methodology is so useful: to get an idea of the stock returns we could see in 2024, we need to estimate what shifts might happen in valuations and earnings forecasts.

This chart comes from strategist Michael Kantrowitz and his team at Piper Sandler. They say that after their recent big surges, neither valuations nor earnings forecasts are likely to rise further from here (you can see their expectations in the orange square). If they’re right, returns for 2024 are likely to disappoint – probably landing in the low single digits like in 1992, 1993, and 2007 – even if we avoid a recession.

Mind you, their view could be too bearish, and multiples and earnings could both rise further. That’s what happened in the late 1990s, after all, when both kept defying expectations and rose for five straight years. It doesn’t seem entirely outside of the realm of possibilities now that AI-driven productivity gains and a more stable economic landscape might give an extended boost to valuations and earnings.

Still, their analysis does force you to ask yourself an important question: what sort of improvement in the economy and sentiment would it take for multiples and earnings to rise further from their current (already high) levels?

My personal view is that another year of double-digit returns for stocks is possible, but unlikely. And even if we do see one, the experience of the dotcom era serves as an important warning: that an exceptional run in returns doesn’t always end well. That doesn’t mean you should sell your stocks and run for the hills: just make sure you’re aware of the assumptions you’re making if you’re banking on another double-digit year.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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