When Profit Falls, Stocks Get Up And Go

When Profit Falls, Stocks Get Up And Go
Paul Allison, CFA

11 months ago2 mins

By now you’re probably familiar with the “bear markets come in two phases” narrative. If you’re not, it goes like this: phase one sees valuations compress, pulling down stock prices in anticipation of a profit recession. Phase two, then, is about the depth of that profit recession – with steeper falls hitting stock prices further. The thing is, that’s overly simplistic and, frankly, doesn’t give investors a lot of credit. Sure, over the long term stock prices track company profit, but in the short term investors do a good job at predicting what’s to come.

This chart shows historical trailing 12-month earnings-per-share growth for the S&P 500 plotted against price performance for the index over that period. You’ll notice that the bottom left quadrant is sparsely dotted. Looking at the left-hand side of the chart (those 12-month periods when profit has fallen) stock prices have actually rallied more often than they’ve dropped. And it makes sense when you think about it. This time next year, how many investors will look back at a year of falling profit in surprise?

But pessimists will tell you that 2023’s profit recession is going to be brutal – worse than most people expect – and that will surely bring another stock smackdown. Maybe so. A negative shock would likely be a blow. But so long as the outlook brightens as the year progresses, investors are pretty good at not dwelling on the past.

So even though it’s only January, focusing on this year could be a mistake, and the sooner you can turn your attention to 2024, and beyond, the better. What actually happens this year will soon become old news. As Warren Buffett famously said at the end of 2008 (in the thick of the global financial crisis): “if you wait for the robins, spring will be over.”



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