Any Ideas On What To Take From This Graph?

The graph to the left is from the Wall Street Journal. It shows the trend for earnings among those companies included in the S&P since 1990. As you can see earnings have tended to grow, on average, at 6% a year.

There’s little surprise in the decline since about the beginning of the recession but the drop in earnings from what appears to be an abnormal amount above trend is rather startling.

I’ll confess to little certainty about what’s going on here or for that matter how to use this information from here on out, but let me throw out a couple of ideas.

You can see that earnings were above trend during the dot com bubble and then again during the housing bubble. I have a hard time ascribing the dramatic uptick that occurred in the middle of the decade completely to housing and its knock-off affects but maybe that’s all it is. If so, that would tell me that once you get housing straightened out things might get back to trend quicker than we think.

As for the cratering of earnings, I suspect that if you did this on a sector by sector basis, you would see an out-sized impact on the overall numbers from the financial services industry. In that sense, the graph probably overstates the depth of the problem with corporate earnings.

Notice that it took a long time for earnings to crawl out of the hole of the 2000 recession but don’t forget that we had 9/11 to deal with. Is that pattern going to repeat? Again, who knows. If the proposition that housing and financial services are primarily responsible for the inflated earnings as well as the depth of the drop then fixing that sector might mean a quick turnaround. The other view is that you can’t fix them that quickly so it will take as long or longer to recover than it did the last time. Additionally, if the rest of the world doesn’t recover as quickly or even if it recovers at a slower pace that’s going to hold down our growth.

What does it mean for stocks. No clue. A guess, though, is to dig into the number further and try and answer some of the questions I posed above. If it turns out that the problems are sector specific then you can start making assumptions about which ones might get back to trend more quickly. Of course, sometimes the most beaten down sectors have the biggest bounce. So look at financial services and housing. Don’t underestimate the power of the federal purse.

You probably have some thoughts that are far better than mine, so leave a comment and tell me how you view things.

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