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When Tracking S&P 500 Earnings Won’t Help As A Market-Timing Strategy

By Brian GilmartinStock MarketsAug 30, 2021 12:13AM ET
When Tracking S&P 500 Earnings Won’t Help As A Market-Timing Strategy
By Brian Gilmartin   |  Aug 30, 2021 12:13AM ET
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This article has been a long-time coming, and will discuss the shortcomings of managing your stock market risk based strictly on S&P 500 earnings estimates.

My late, great, friend, Jeff Miller, who left us in May, 2021, used to talk to me all the time about the correlation between S&P 500 earnings estimates and the S&P 500 itself. Jeff would show me charts and graphs and was actually the inspiration behind the start of these posts, since he knew that I followed S&P 500 earnings data, although it was initially more from a sector perspective than the overall index itself.

Jeff and I used to contribute to Jim Cramer’s “TheStreet” back in the early 2000’s and he would see my posts on sector earnings for the S&P 500, and we started to dialogue from that original topic.

The point being that there is a relationship or correlation between S&P 500 earnings and the S&P 500 itself, but I suspect it’s more coincident than leading.

If readers are perusing my articles looking for a “sell everything” call on the stock market, you’re going to be sorely disappointed.

Here’s why tracking S&P 500 EPS data is not a perfect (or even almost perfect) market-ting tool:

1. P/E Compression

Readers have to look only at the first decade of the 21st Century, from 2000 to 2009, to realize that “P/E compression” is the hallmark of a secular bear market.

S&P 500 EPS vs S&P 500 Total Returns
S&P 500 EPS vs S&P 500 Total Returns

This table shows the last 30 years of S&P 500 EPS growth (y.y) accompanied by the total return for the benchmark for that respective year. In the decade of the 1990s, when the “average, annual” return for the S&P 500 was 18.19% per year, in 1994 S&P 500 earnings grew 19% while the S&P 500 returned 1% thanks to the 6 fed funds rate increases by Alan Greenspan. That was the one year of PE compression for the entire decade.

Now look at 2000 – 2009, when there were 3 years of PE compression, 2 of which were the NASDAQ revaluation from 2000 to late 2002. (More on this in a minute.)

For the entire decade of 2000 – 2009, S&P 500 earnings grew 20%, from the final 1999 print of $50.82 to the final 2009 S&P 500 EPS print of $60.80. However the cumulative return for the S&P 500 for those same 10 years was 11% – 12% (per Morningstar Ibbotson data). Basically, according to Ibbotson, the S&P 500’s “average, annual” return was 1.5% per year for the entire decade. (Ycharts shows a negative 0.5% average annual return for 2000 to 2009.)

The 2000 to 2009 decade saw two 50% corrections in the S&P 500 for two entirely different reasons. It was an ugly period and despite the fact that S&P 500 EPS grew cumulatively 20% for the decade, the S&P 500’s cumulative return fell short of that mark.

2. Business cycle recessions vs exogenous shocks

Tracking S&P 500 estimates only really would give you a market-timing signal when we would have a “traditional” business-cycle recession, like we did in 2018. After the S&P 500 fell 18.9% in Q4 ’18, after Jay Powell raised the fed funds rate to 2.25% – 2.50% in December ’18 and then promptly had to reverse course with monetary policy.

The “forward estimate” S&P 500 EPS estimate peaked in late September ’18 and then started to roll over, but that’s not unusual. The “normal” pattern pre-COVID-19, is that the “forward 4-quarter” S&P 500 estimate peaks early in each quarter and then gradually declines.

Exogenous shocks are shocks to the US economy, like 9/11 and then the COVID-19 pandemic. These are events that exert significant influence on the US economy, but are not precipitated by natural business cycle events.

LizAnn Sonders of Charles Schwab and Bob Doll, who was at Nuveen at the time, were quick to turn cautious as we entered Q4 ’18.

The point being is that sometimes the S&P 500 EPS data gives a false signal. Much like the old saying about the Leading Economic Index indicator and it’s forecasting 9 of the last 3 recessions, the S&P 500 EPS data can look grim for some time periods and then the estimates ultimately get revised higher.

3. S&P 500 is a market-cap weighted index

Covered in part by “PE compression” which is a result of the market-cap weighted influence of the S&P 500 index, but to put a finer point on it, as we saw from 2000 to 2002 in the S&P 500, the collapse in technology, and really large-cap growth like Walmart (NYSE:WMT) and Home Depot (NYSE:HD) as well, exerted a significant influence on the S&P 500 while the vast majority of the stocks within the S&P 500 weren’t impacted.

Frankly, you could make a good case that we (readers and investors) are seeing a similar situation today in the S&P 500: the top 6 names in the S&P 500 (S&PY) as of the Friday, Aug. 27, 2021 close, are now 24% of the S&P 500’s market cap. What’s even more interesting is that Nvidia (NASDAQ:NVDA) is now the 6th largest stock by market cap in the S&P 500 (that’s new). Apple (NASDAQ:AAPL) and Microsoft (NASDAQ:MSFT) are now 12% of the S&P 500 by market cap (top two names ranked #1 and #2, respectively). Apple and Microsoft are 50% of the tech sector's “earnings weight” as well.


The top 10 positions in the S&P 500 by market cap are only 9 companies since the benchmark holds both the Class A and Class C shares of Alphabet.

Occasionally I think about “what if” the top 10 companies in the S&P 500 suddenly had their EPS reduced by 50%—consider the damage to the benchmark in terms of total return that we’d see and yet the vast majority would likely be ok, depending on what caused the 50% decline in those respective earnings results. That would be a situation that would be similar to 2000 through 2002, where the S&P 500 corrected 50% from it’s March, 2000 high to it’s October, 2002 low.

During that time we also saw the contested Presidential election of 2000, 9/11, and the Enron and Worldcom frauds.

Pretty much everything that could go wrong with the market, did go wrong.

The goal of this article is to caution regular readers that the US stock market is a discounting mechanism and very often changes direction well before fundamentals change. The same is true with individual stocks. My most memorable cautionary tale for readers is Cisco Systems (NASDAQ:CSCO) in late 2000, 6 weeks after Intel (NASDAQ:INTC) warned, when Cisco reported in early November, 2000.

John Chambers raised their February ’01 quarterly guidance and said business remained healthy. Cisco’s stocked had peaked at $82 in April, 2000, and was trading around $55 per share at the time of the November ’00 earnings report. It rallied smartly for a week or two after Chambers guided higher, then turned lower and kept going. By early February ’01, Chambers then lowered their 2001 guidance and the stock fell all the way to $11 per share in October, 2001. Cisco’s stock lost 86% of it’s market value in 19 months.

The Fed and the macroeconomic landscape look supportive for the next 3 – 6 months, and so does the S&P 500 3rd and 4th quarter, ’21 earnings and revenue data, but know that the world can change quickly.

Writing about topics like this helps flush out my own thinking on topics such as tracking S&P 500 EPS estimates. Hopefully readers found it somewhat helpful.

Know that there is no perfect market-timing signal. Readers should get the point by now. It’s always an imperfect process. Take everything you read on financial media with skepticism.

When Tracking S&P 500 Earnings Won’t Help As A Market-Timing Strategy

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When Tracking S&P 500 Earnings Won’t Help As A Market-Timing Strategy

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Comments (1)
Solomon Lalani
Solomon Aug 31, 2021 1:22PM ET
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Thanks for your continued contribution - I really appreciate these.  Jeff Miller's charts were wonderful - thankfully Jill Mislinski is continuing his work and doing a good job!  Do you also have NQ EPS, PE historic data, and analysis along the lines presented in this article?  Please contribute/share if you have that - it would be interesting to dive deep into the engine that has been driving the economies of the world for the last 3 decades.  Thanks
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