Stock market myths, and what’s wrong with the economy

Stock market myths

Over the decades we have all learned to accept that earnings drive stock prices. Rising earnings – rising stock markets and stocks. Falling earnings – falling stock markets and stocks. In fact, there have been numerous studies, using current, future and lagging earnings, to determine an appropriate market price earnings multiple. Then standard deviations from that multiple are used to suggest a risk-on or risk-off investment climate.

With SPX GAAP earnings on the decline from $106 to $91 over the past year. We took a look at the history of stock market activity verses GAAP earnings since the 1920’s. Nearly 100 years. We found something completely different than what we had expected. As you can easily observe from the chart below the noted generalization, rising/declining markets during rising/declining earnings, does not hold up very well over time. This observation might help to explain the oddity: why growth companies, with hardly any earnings, can sell at PE multiples in the 100’s. While cyclical companies, during the same period, with the same revenues, can sell at PE multiples in the single digits.


After analyzing the chart data in detail, and using OEW analysis from the years 1921 to 2015, we determined there have been 33 bull/bear markets. Seventeen bull markets and sixteen bear markets. Then after analyzing each of the bull/bear markets individually, plus allowing for earnings to top/bottom within one year of a stock market top/bottom, we found that earnings are correlated with the stock market slightly less than 58% of the time, i.e. 19 of the 33 times.

In fact, we found nine instances when the stock market and earnings moved in completely opposite directions. Seven times earnings rose throughout an entire bear market, and twice earnings declined throughout an entire bull market. Simply put, 27% of the time earnings and stock market prices move in completely opposite directions. During the remaining five periods, earnings trended up/down within the five bull/bear markets.

While reviewing all these bull/bear markets we made note of their PE multiple peaks and lows. Bull market multiples have peaked at as low as 9 in 1980, and as high as 35 in 2000, with the mean PE at 19 in 2007. Bear market multiples have bottomed as low as 6 in 1949, and as high as 23 in 2002, with the mean PE at 11 in 1957 and 1984. What was also surprising was the PE multiple at the highly acclaimed “wildly speculative” 1929 peak was an historically normal bull market PE of 20.

Another common belief is that interest rates have an effect on market price earnings ratios. So we took a look at that relationship also. We were able to start this analysis during the 1932-1937 bull market, dropping the total bull/bear markets covered to 31. What we found is that normal short term rates of 6% or less have little impact, if any, on market multiples. The only times we noticed a definite impact was during the 1978-1980 advance and the 1982-1983 advance. Rates peaked at 15.0% during 1978-1980, and that advance ended with a PE of 9. Rates peaked at 9.0% during the 1982-1983 advance, and that one ended with a PE of 13. These two advances were the only times short term rates hit over 7% during a bull market in the entire study. Normal short term rates, under 7%, have little to no impact.

Conclusions and further observations

Since corporate earnings are rising with the stock market only 50% of the time, they are not the determining factor to create and/or sustain bull markets. Investor confidence in the economy, or an individual company, along with future expectations drive bull markets. Investor sentiment is the driving force. Individual stocks can sell at multiples in the 100’s, if confidence in future growth is strong. While stocks can sell at multiples in the single digits, if confidence in future growth is lacking.

While mergers and acquisitions can make companies bigger and more cost effective. This does not directly translate into higher investor confidence. It just creates a larger company. A strong management team and consistent results are more important.

Stock buybacks, aimed at decreasing the amount of shares outstanding, which should translate into lower PE multiples and higher stock prices. Does not directly increase investor confidence either. Especially when debt is used to buy back the shares. It just creates more debt.

Laying off employees during an economic downturn, and/or a decline in revenue or gross margins, does not directly increase investor confidence. It only makes a company look cyclical. Which as noted earlier generally goes hand in hand with lower PE multiples, and a lower stock price.

In summary, M & A, stock buybacks and laying off employees, all of which are quite popular activities in recent decades, do not automatically translate into higher stock prices. They simply represent an active management team that is short term oriented. What drives up stock prices is long term planning, and consistency in meeting long term goals. This increases investor confidence, and it alone drives up stock prices. When investor confidence is high bull markets unfold, whether or not, earnings are rising or not. The same thing could apply to individual stocks, and it does at times.

The Economy

While continuing the GAAP earnings analysis we took a look at Real GDP growth during all the bull/bear market periods from the 1930’s. Overall we did not observe any direct correlation between GDP peaks and Bull market peaks. However, we did observe something interesting which confirmed our suspicions.

When we throw out the volatile 1930’s and 1940’s, created by depression rebounds and war demands, we find that Real GDP growth moved above 5% during economic expansions, and below 0% during contractions. This continued from the 1950’s until it stopped in the mid-1980’s. Since the mid-1980’s peak growth has been under 5% and getting less and less.

Data: 1984-1987 +4.2%, 1987-2000 +4.9%, 2002-2007 +3.8%, and 2009-2015 +2.5%.

The cause, and problem, is easily observed in the Federal Debt as a percentage of GDP link. In the mid-1980’s this ratio first approached, and exceeded, the 50% threshold. Since then it has continued to rise, and even the decline in 2000 held above 50%. Until the government gets debt back under control, GDP growth will continue to be weaker than it should be for a country as innovative and productive as the USA.

About tony caldaro

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57 Responses to Stock market myths, and what’s wrong with the economy

  1. valunvstr says:

    Market action in Europe today is clearly a sign that the end is near. For the US, the SP500 has tested teh 100 day ema. If it holds, it might give the SP500 support to make one more move higher. The market is battling with the 200 day ema and has failed 3 times in the last 5 days. If the 100 day ema holds, the the 200 day sma might finally be in sight. Time will tell. JMO

  2. Peter Ewing says:

    Economist John Hussman has done some eloquent work on this subject of estimating future market returns and the bottom line is this:
    “It can be shown that the 10-year total return of the S&P 500 can be reliably estimated by the log-values of two variables: the S&P 500 price/book ratio and the equity turnover ratio (revenue/book value). Why should these unpopular measures be reliable? Simple. Those two variables – together – capture the valuation metric that’s actually relevant: price/revenue.”

    A more detailed explanation can be found here:

    Geek alert: Lots of math here ! Bottom line is the return of the S&P 500 for the next decade will be about 2% with a lot of volatility to achieve that. The market is about 100% overvalued on the metrics that stand the test of the past century.

    • valunvstr says:

      Look at Hussman Funds. His 10 year returns are NEGATIVE. He’s been bearish since 2009 and never got bullish. He will eventually be right but who isn’t how sticks to only one point of view. The guy might be a smart economist. His investment conclusion have been nothing short of some of the worst in the industry. And he gets caught leaving data out to fit his story too. It recently happened where he argued the technical setup leads to crashed but left out 9 other times it’s happened and the market did not go lower. Sentiment Trader busted him on that. I’m a bear but he is laughable from an investment perspective.

  3. Thank you, Tony, for this analysis.

  4. ajww says:

    Just a shout out to thank you for your great analysis which is so good I read it twice

  5. Thanks Tony. Greatly appreciated as always.

  6. I would just like to say thank you Tony! Not only for this brilliant piece but for your daily generosity and for your love of the markets.

  7. purplember says:

    Tony, just a couple of thoughts to add here:
    1. notice how the SPX has outpaced GAAP earnings in your chart since 1990. is this premium here to stay or will it revert back to the mean (or possibly overshoot to the downside) at some point to usher in the next BULL market ?
    2. Debt & baby boomers – our national debt is $19 trillion but with medicare and social security it’s over $100 trillion. there used to be like 16 workers per each retiree. in 2025 it will be ~4 workers per retiree (your taxes going up). i don’t know the impact of baby boomers hitting retirement / not investing in stocks as well as debt levels going up and working class will have to pay more to cover expenses of social security / medicare. i just don’t see many positives here !!

    FED govt takes in ~$4.1 trillion in revenues and ~80% goes to social security / medicare / interest on debt. FED can’t allow interest rates to go up cuz it will chew up all tax revenue. Bush/Obama created a mess with wild spending – we need to get off this train of “FREE stuff” for everyone.

    • tony caldaro says:

      Already seeing stocks selling at single digit PE’s. This bear might cause the reset.
      The US Gov’t has $19T in debt, and nearly every government has unfunded potential obligations in additional debt. People on Social Security are already paying for their Medicare. The problem is not with the obligations. It is with how the obligations are being managed.

  8. tomasso60 says:

    nice work Tony – insight and look at variables most have not considered makes one think.

  9. agenthutton says:

    Take a look at current Velocity of M2 Money Supply, never been lower by a long shot in over 50 years, and M2 grew by 66% since 2008.

  10. johnnymagicmoney says:

    Looking at the screen and just looking at NOOOOOO movement so I went to the Google chart and watched the ticks over a four minute period. These were the buys/sells

    3 shares, 30, 2, 80, 50, 3, 3, 50, 1,000, 16, 5, 5, 4, 35, 4, 100

    not a lot of institutional buying there over 4 minutes

  11. asw 20 says:

    Superb analysis. Thank you, Tony, for this and all your daily and weekly updates.

  12. valunvstr says:


    Take a look at the Rule of 20. When trailing “as reported earnings” PLUS trailing 12 month CPI is 20 or more the market is expensive. It either gives below market returns or coincides with market tops. Everyone talks about interest rates, but it is really inflation that both the bond and stock market care about. CPI in 1980 was 13.5 so the PE of 8 that you mentioned actually made the market expensive. Outside of the late 1990’s (1995 the combo was UNDER 20 for the first time since 1991 by the way) it has worked very well. The exception is when you have deflation. Of course, you can’t subtract CPI from the PE. Deflation is a disaster so a PE of 20 is a big problem, ala 1929 where you had a negative CPI and PE of 20+. I’ve noticed over 22 is a real problem. Today, as you mentioned, the PE is 22. CPI is 1.73. That makes the market very expensive. Nothing says it can’t get more expensive however outside of the late 1990’s bubbly (1996 and later) it is rare you got very good returns with a combine PE + CPI of almost 24. That’s a valuation mess.

    • valunvstr says:

      Here are the two links I have bookmarked that get updated daily. CPI ticked down to 1.37. A correction from my post above.

    • tony caldaro says:

      Wouldn’t the CPI be reflected in short term rates?

      • valunvstr says:

        Not the same in all time periods, no. That would assume that short term rates would be at the exact same level for a certain CPI rate. For example, 3 month T Bills in January 1992 were 3.9% and in January 1996 were 5.15% yret CPI was 2.6% and 2.7%, respectfully. You won’t see that a CPI rate at a certain level at a certain point in time producing an interest rate that is always the same. That’s why the FED model is broken. Look at Japan. Low interest rates have not produced good stock returns, mainly because they have been finding bouts of deflation for decades. It’s more about Inflation and Deflation, than it is interest rates. The is why valuations have been higher during periods of lower and stable inflation rates but valuations have been much lower during period of higher inflation and deflation. Interest are of course correlation which I believe is the point you are getting at, but there are not correlated one for one and therefore don’t make for as good of a valuation tool as CPI. That’s why the FED model does not work and the Rule of 20 (I like 22) seems to.

        • valunvstr says:

          Sorry for the poor grammar. I typed quickly and made several errors.

        • tony caldaro says:

          will try to look into it

          • valunvstr says:

            Yes. If there is deflation than of course CPI doesn’t get subtracted. Also, it doesn’t not necessarily mean a big bear market is coming. If you bought in January of 1991 the PE + CPI was exactly 20. The market did not crater but even bonds would have performed better from 1991-1994. The market in 1995 was again reasonably valued and it took off. So, it doesn’t mean bear market but if you look at Bear market tops, they have coincided with this metric being over 20 and in other markets you just get mediocre performance like 91-94. 1980 was a good example. PE was 7.39. Wow right? For a market top! But CPI was 13.91%. In 2007 no one had a problem with valuation but the PE was 21.46% and CPI was 4.28%. It’s a good tool to put in the tool box that want a valuation metric that works better from a timing perspective. Valuation should NEVER be looked at in a vacuum but this one that few know about that seems to be more reliable than most.

          • tony caldaro says:

            Just looked into it.
            Doesn’t seem to have any impact until the CPI, like short term rates, gets over 6%.
            We had two bull market peaks in the 1950’s at PE’s of 11 and 13, with the corresponding CPI’s at 0.4% and 2.2%.

          • valunvstr says:

            Two bull market peaks? What two? 1957 (CPI 2.9%)? But that was barely 20% and was very short lived. What is the other one? 1960’s to 1974/75 would have been out of market too.

  13. simpleiam says:

    Great article, Tony! Thank you so much. Will distribute link to my Market Buddies.

  14. gtoptions says:

    Thanks Tony, great info.

  15. mjtplayer says:

    Thanks Tony!

    For those who are curious as to GAAP earnings and P/E, stock-charts provides both.

    GAAP S&P Earnings = $90.66!GAAPSPX

    P/E = 22.08!PESPX

  16. ISINCODE says:

    Excellent piece of work ! Thank you

  17. lbhkinqa says:

    Great write up Tony!

  18. bolderbob says:

    Tony, Bravo! This is superb insight based on facts. We are all taught myths and few question them but those who do have an edge. Investor Confidence seems to be the key. What measures do you use to determine this?

  19. bud67 says:

    Outstanding work….

  20. thecustomer14 says:

    My favorite thing you’ve written in quite some time… thank you, Tony, for this and everything else you share with us.

  21. rc1269 says:

    Great writeup Tony – Thanks!

  22. 123 abc says:

    Tony et al, thank you for sharing an interesting article, much appreciated; shall be circulating to younger ‘economists’ in the family.

    This study appears to be somewhat similar to socionomics, i.e.

    Standard View
    Recession causes businessmen to be cautious.
    Talented leaders make the population happy.
    A rising stock market makes people increasingly optimistic.
    Scandals make people outraged.
    Happy music makes people smile.

    Socionomic View
    Cautious businessmen cause recession.
    A happy population makes leaders appear talented.
    Increasingly optimistic people make the stock market rise.
    Outraged people seek out scandals.
    People who want to smile choose happy music.

  23. dwr51 says:

    Just a comment about debt to GDP. If one goes back far enough to the late 30’s and early 40’s one would find that Debt to GDP was approx.120%. That of course can be attributed to the cost of the war effort, it created may well paying jobs that in turn added to the government coffers in the form of taxes collected. This then over the years brought debt to GDP back under control. When the warriors returned home new technologies helped them return to a work place in which the new technologies created demand the world over. In 2007-2009 there was not a great war taking place but due to many factors that we are all aware of the economy tanked. So unlike the 40’s with its job creation we were in a position of having maintain jobs with the bailouts of the auto, banking industries as well as others indirectly. So my point is that although Debt to GDP is high and needs to be brought back under control we have been higher and survived. In the great scheme of things I believe that we are having a hiccup and the ship will right itself. In my opinion we will again survive and prosper in time.
    As always respectfully

  24. manunidhi21 says:


  25. joemal97 says:

    Thank you Tony! .

  26. Investor confidence.Is that Goldman Sachs or mom and pop?The myth used to be long after institutional investors have made their fortunes,the retail investor jumps in-just in time to feel bear claws.Investor confidence is born by the chart moving from lower left to upper right and seeing results on their quarterly financial statements.Agree?Good report Mr C .Makes the market seem more random fundamentally than ever.If Gold could keep rising,a good example of investor confidence moving that market–or fear of the other markets?

  27. fotis2 says:

    This is very interesting research you have posted many thanks Tony a keeper for sure!

  28. magnus1234 says:

    Thank you Tony. Interesting reading. This topic has been bugging me for a long time. It seems to be related to another trend that it is “only” the top 20% of the SPX that stands for the growth the rest have an almost flat growth. I share the info as soon as I find it.

  29. ABchart says:

    Thanks Tony.
    SPX: historically, excluding QE periods , what is the PE level that encourage insiders to buy? 12? 15?

  30. very interesting. thanks for sharing. So Fundamentals are not key in determining where we are in the Bull/Bear cycle and Market psychology/sentiment above all matters most?

  31. Hugh Jazole says:

    “Investor confidence in the economy, or an individual company, along with future expectations drive bull markets.” It seems oil/gasoline prices have a big impact on this, especially if they are rising rapidly.

    “GDP growth will continue to be weaker than it should be for a country as innovative and productive as the USA.” There are many that believe new technologies coming online within the next decade or so, will dramatically improve production. Most of these unfortunately do not involve humans, and since taxing peoples labor is the governments bread and butter, I would love to see how they are going to increase taxes.

  32. Thanks for sharing this Tony.

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