Keri Russell in “Cocaine Beer”. universal
Bearish investors often point to two charts to confirm why they are negative on stocks.
But according to Ed Yardeni, bears get it wrong because they misunderstand what really drives stock market performance.
“We think the trend in the stock market is mostly driven by the trend in earnings,” Yardeni said.
There is a lot of skepticism about where the stock market goes from here as investors worry about everything from a potential recession to a debt-ceiling impasse that could lead to US defaulting.
No matter what the root cause of the day, week or month, bearish investors often highlight two different charts that help confirm their negative outlook on stocks.
But market veteran Ed Yardeni isn’t buying it, and in a Monday note he said the bears are wrong with those two charts because they fundamentally don’t understand what drives the stock market up: corporate profits.
“We think the trend in the stock market is mostly driven by the trend in earnings,” Yardeni said, and that trend has increased over time.
Here are two charts often used by bearish investors, and Yardeni’s take on them.
1. The Fed’s Balance Sheet Versus the S&P 500.
This chart shows the S&P 500 overlaid on the Fed’s growing balance sheet. Bearish investors argue that the bull run in stocks from 2009 to 2021 was driven entirely by the Fed’s quantitative easing programs.
Now that the Fed is reducing its balance sheet by about $100 billion on a monthly basis, stocks are due to fall, or bearish.
“The S&P 500 hit a record high on January 3, 2022, as investors began anticipating quantitative tightening, which began during June of that year. The Fed remains on its QT course, which in suggests to bears that the rally from October 12, 2022 is a rally within a bear market,” Yardeni explained.
But as long as corporate earnings continue to rise, the stock market could rally in the face of a declining Fed balance sheet, as it did in 2017 and 2019.
“We suspect QT will cause either an economic or earnings recession, let alone both. In our ‘rolling recession’ scenario, earnings growth could weaken, but it should be positive,” Yardeni said.
2. Year-on-year growth of the M2 money supply.
“Another current favorite chart of Permabears is the year-on-year growth of M2. M2 was down 4.1% year-on-year in March, the lowest growth rate on record, they point out. But this was followed by a record-high had a growth rate of 26.9% during February 2021,” Yardeni said.
The idea of a recession is that with less money slowing its way throughout the economy, less money will be able to flow into risk-on assets like stocks, essentially removing a bullish factor from the equation. But Yardeni revealed a third chart to offer a different perspective on the M2 growth rate.
Instead investors should focus on the full chart of M2 money supply and deposits at commercial banks.
The chart shows that both M2 and total deposits in commercial banks remain roughly $1 trillion to $2 trillion above their pre-pandemic trend. So, while growth has slowed recently, it is a natural side effect of the surprising gains experienced during the pandemic.
Instead of focusing on those charts, the bears would do better to focus on corporate earnings growth, which is expected to experience a slight decline this year. Fidelity’s chart Jurien Timmer explains Long-term direct correlation between stock prices and earnings.
“The scatter plot below is a good reminder that over the long term, stock prices tend to follow earnings,” Timmer said.
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