Stocks Getting Cheaper as Forward Earnings Projections Outpace Price Gains

Stocks are less expensive than they were in January. That may sound unlikely with the index near a record, but forward earnings for the S&P 500 have grown roughly twice as fast as prices this year. Ed Yardeni describes it as FEMO, fabulous earnings momentum, rather than FOMO. However, investors are getting more future earnings per dollar than they were eight months ago.

The economy has done its part. This expansion is mature, but it is still being supported from several directions: corporate spending on AI, household spending that has held up better than most expected, and government spending on defense, infrastructure and energy security. As per the International Monetary Fund, global economic growth nearing 3% going into 2027 remains a reasonable assumption.

Earnings have followed this economic growth, and the rally has widened. Technology is no longer carrying it alone – industrials, materials, energy and health care have all participated, and higher oil prices are helping energy company profits. The largest names, which led the market for the past two years, have been comparatively quiet.

Margins are the development worth paying attention to. Earnings are growing much faster than revenue, and historically that happens closer to the beginning of a bull market than the end. The earnings growth looks to be the result of real productivity gain from companies. Analysts' long-term growth estimates have become optimistic, although companies have generally continued to beat them.

None of this makes the market straightforward. The energy shock in the Middle East has brought headline inflation back into the discussion, and central banks are now more inclined to wait than to cut interest rates again. At roughly 20 times earnings, there is limited room for disappointment if inflation reaccelerates or bond yields continue to rise. From here, further gains likely require three conditions: earnings continue to come through, underlying inflation stays contained, and long-term bond yields remain stable.

The third condition is the least certain. Governments are borrowing heavily, defense and energy budgets are expanding, central banks have stepped back as buyers, and a substantial portion of the AI build-out is being financed with debt. Long-dated bond yields are near multi-year highs, and there is little on the horizon that would obviously bring them back down.

Commodities continue to serve a purpose. Oil carries a geopolitical premium if the Strait of Hormuz shipping remains at risk, and gold continues to provide a hedge against deficits, a weaker dollar, and further geopolitical escalation.

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Michael Holden
Portfolio Manager
Q Wealth Partners