176th Edition
Stock market returns, valuation, and an earnings boom
From the stock market bottom in March 2009 through mid-July 2026, the S&P 500 achieved an annualized return of just over 17%. Over the most recent 5-year period, (July 2021 to July 2026), the annualized return was approximately 16.5%. These returns compare quite favorably to the long-term average annualized return of slightly over 10%.
Currently the PEG (Price/Earnings ratio divided by the earnings growth rate) for the S&P 500 is .79x, well below its long-term average of 1.3x How can the market appear to be so undervalued after a multi-year run that dwarfs the long-term averages?
I believe there are three primary drivers of this current phenomenon. First, it appears that we are experiencing an earnings boom. The impact of AI and other advanced technologies have enabled companies to continue to increase productivity, resulting in accelerating earnings growth. Currently, this trend looks sustainable.
Second, from a global perspective, the U.S. economy and stock market continue to look relatively more attractive than the rest of the world. While it is always messy and never perfect, capitalism continues to produce greater economic growth and more opportunities to create wealth than totalitarian regimes and centralized state-dominated economies elsewhere.
These first two driving forces behind the recent bull market are well-documented. Strangely, both factors are frequently criticized, and these objections actually create the third driving factor supporting a strong stock market and a valuation that at least historically does not appear to be excessive.
The third driver is less quantifiable compared to the first two, but no less important. It involves sentiment and expectations. With fear of AI a recurring theme in certain circles, and animosity, if not outright hatred, for capitalism just as prevalent, a wall of worry of epic proportions is created. How does this work, exactly? Basically, our worst fears, almost by definition, continually prove to be excessive when compared to reality. The collective sigh of relief that invariably occurs pushes the stock market higher. Hence the timeless statement, the market climbs a wall of worry. Pundits historically understate the importance of sentiment and how it interacts with expectations, probably because it is the least quantifiable driver of the stock market.
All this begs an important question – What factors could change the fundamental outlook for the stock market and threaten the sustainability of this recent bull market? Here are a few worth monitoring:
- Socialism – How widespread and how long before we realize how bad it always is in terms of creating sustainable economic growth?
- Fed tightening in response to too much inflation. Keep in mind, the Fed rarely gets monetary policy right.
- Geopolitical – Disruptions impacting world trade or military confrontation (with China).
When it comes to predicting the future of the stock market, there are always issues to worry about. That is a good thing, not a bad thing.
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Michael Kayes
*These views are my personal opinions and are not the viewpoints of any company or organization.