Demand Often Precedes Earnings

Posted in: Economics, General, Stock Market, Thought of the Week

The Investment Committee has repeatedly heard concerns this year from market pundits and various media sources that equities are headed for a down year in 2014 simply because they performed so well in 2013. However, it seems a little far-fetched that some mysterious gravitational force can control the future of equities.

Over the past six years, our Investment Committee has developed a strong relationship with Sanford C. Bernstein, one of the most respected equity research firms in the world. Bernstein’s research team recently published a chart that explains why equities performed so well last year. They say that demand for equities pushed the S&P 500 higher by 22%. Additionally, earnings growth accounted for 4% and dividends and stock buybacks accounted for the remaining 5%. The subsequent year following a large demand for equities (2014) is mostly driven by earnings. Simply put, demand for equities typically does not drive performance two years in a row.

According to their research, large cap equities historically return 17% the year following one driven mainly by a rise in demand for equities. While the past does not always predetermine the future, Bernstein’s analysis carries two implications for investors:

  1. Markets are Anticipatory: The reason why demand for equities has historically preceded earnings growth is that equity investors anticipate such moves. If an investor believes that earnings in a company will rise over the next 2-3 years, they will buy stock before the earnings have actually risen.
  2. Stocks Aren’t Doomed: Investors are anticipating that an improving economy will deliver higher earnings in 6-12 months out. If these market participants thought otherwise then the market probably would have performed quite differently last year. Stocks don’t have to fall in 2014 just because they soared in 2013.

To sum it up, a large part of rising demand for equities came from the belief that better days are ahead for equity markets. Recent earnings trends continue to support a slow and steady recovery, and our Investment Committee remains bullish in their long-term outlook on equities over the next several years.

Read this week’s Thought of the Week to learn more about our Investment Committee’s outlook for 2014.

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As an Investment Advisory Representative working in conjunction with Global Financial Private Capital (GFPC) we are provided weekly thoughts on what is happening in the economy and the market. Written by our investment committee at GFPC we find these thoughts to be informative and interesting.