The stock market’s recent trend could be described as just going higher — with the S&P 500 setting its intraday record high of 4,257 on Tuesday. Despite bubble concerns and pockets of investing mania, fundamentals are supporting it.
Why it matters: The stock market has rallied almost unabated in the past year, more than recovering all of its early pandemic losses, leading some to question if prices have detached from economic reality and gotten frothy.
Be smart: No discussion on stock prices is complete without addressing earnings, specifically expectations for earnings growth. After all, the theoretical value of a company is the present value of all of its future earnings.
What they’re saying: "The rally in stocks over the past year has been driven entirely by fundamentals," Credit Suisse’s Jonathan Golub wrote in a research note, adding that the trajectory of stock prices and the earnings expectations have been rising almost hand in hand as seen in the chart above.
The other side: Skeptics note that the market’s valuation — as measured by the ratio of price divided by expected earnings — is around 21. This is significantly above its 10-year average of 16, suggesting that stocks may be overvalued.
Yes, but: Many experts ranging from the billionaire investor Warren Buffett to the Fed chair himself Jerome Powell have long argued that historically low interest rates justify elevated valuations like what we're seeing today.
The bottom line: Stocks are inherently risky, so there will always be reasons to be worried about prices falling. But lack of earnings growth is not one of them. And earnings growth is the most important driver of value.