Not the beginning of a bear market
Since the middle of February the stock market has gone nowhere and many investors are worried that this could be the beginning of a major drop in stock prices.
We don’t think so. And the chart below is the main reason for our optimism. This chart goes back 120 years and shows the earnings, or profits generated by the businesses in the S&P 500.
As you can see, in 2010 earnings recovered to near the old peak set in 2007. Based on first quarter results and reasonable projections for the year, 2011 will be a record year for earnings.
The pace of earnings growth is in the process of slowing, but not the growth. In fact, more records can be expected in the next couple of years barring some major event. Those earnings will carry stock prices higher.
But the earnings reported today are a lot different than those in 2006-07. Back then over 40% of the S&P 500 earnings came from financial companies and finance was the biggest sector by market value.
Today, Energy and Technology lead the way, producing record profits, while financial stocks remain well below their old highs both in prices and earning power. Of course, we learned in 2008 that those profits at banks and brokers were largely fictitious. Today’s profits are of a higher quality and result from the sale of actual stuff and for that reason can be trusted more than the 2007 variety.
The current correction is probably not over, but a few months of sluggishness is no reason to change our view about 2011. We hope to use this period to increase the earning power in our portfolios and reduce the risks that are always present.
Daniel A. Ogden