I am often asked “What makes the stock market do well?” The answer is complicated but at the same time simple both in the short-term and also long-term.
In the shorter-time frames, the stock market maybe driven by emotions like greed or fear. Greed to make money and then two different kinds of fear. Fear of loss but also fear of missing out. I think most of us understand the fear of loss whether it be a financial loss during market declines or the loss of something important like a loved one. However, the fear of missing out is also a motivator to join in during a period of dramatic market growth. Perhaps this is also a form of greed.
The short, simple answer to why markets move in the short-term maybe media-driven publicity and speculation. Occasionally, short-term movement is initiated and supported by facts but more often maybe promoted by “opinions.”
While short-term movements in the stock market maybe driven by emotional fear and greed, longer-term “real growth” tend to be more of a “numbers” thing. By numbers, I mean, real stuff that is actually counted and reported in audited company financial reports and government agency reporting. I will briefly explain three of these important “numbers.”
Two of the “numbers” are revenue (also known as sales) and earnings (also known as profits) of public companies. Usually, these numbers are reported quarterly. When these numbers are reported they are compared with either the previous quarter or the same period in the previous year. At the same time companies report what just happened with sales and profits, they make a prediction of what they anticipate the future will be. You could perhaps call future earnings or revenue estimates to be a goal or benchmark to measure future performance. Companies are careful not to set their estimates too high for fear of missing the mark and “disappointing” investors who then could be less inclined to want to own their stock.
Revenue growth or decline is pretty easy to understand. It is usually important to sell more of your product or service now than you did before and more tomorrow than today. As an example, preliminary revenue growth as of February 12, 2021 for the 500 companies that make up the S&P 500 is projected to grow by 2.8% in the 4th Quarter of 2020 when compared to Q4 of 2019. (1)(2). This is good.
Note: The S&P 500, is a stock market index that measures the stock performance of 500 large companies listed on stock exchanges in the United States.
When comparing what companies were projecting the future to be for the 4th Quarter of 2020 versus the results they are now posting, 74% of companies reporting so far have exceeded revenue projections for the 4th quarter of 2020. Results indicate sales / revenue are up by an average of 3.3%. If this number holds (not all companies have reported yet), this will be the largest “earnings surprise” since FactSet began measuring it in 2008. All of this positive revenue is occurring during the COVID19 pandemic.
While revenue is important (you have to have sales), earning or profits is the critical “number.” A company can have sales growth without profit. It is not unusual to find companies with a great idea or even tremendous sales that never makes a profit. The “dot.com” companies of the late 90’s are an example of “lots of promise and no profits.” (6) Sustained and growing profits are a sign of a healthy company. Sustained and growing profits by many companies are a sign of a healthy economy. This is why people measure revenue and earnings growth of a wide segment of companies.
As of February 12, earnings for the 500 companies that make up the S&P 500 are on schedule to grow by roughly 2.9% in Q4 2020 over Q4 2019. “Looking at future quarters, analysts project double-digit earnings growth for all four quarters of 2021” as reported in FactSet. (1) Traditionally, this is considered a very good sign for the stock market.
The third critical “number” is retail sales. The U.S. consumer spending makes up 70% of U.S. GDP (gross domestic product). (4)(5) Therefore, when the consumer is spending more money now than in a previous quarter, one often assumes that the revenue of companies will go up and so will profits / earnings. As discussed earlier, increased earnings will make the company more valuable and the stock price could likely go up.
In January, 2021, retail sales were up 5.1% from December 2020 and 10.8% higher than January 2020. (3) In spite of COVID lock downs, continued high unemployment and other economic malaise, the consumer is continuing to not only spend money but spend more money than before. Again, a good sign for the economy and potentially a good sign for the stock market.
In summary, shorter-term stock market rallies / declines can be initiated by news about “the numbers” but often are accelerated by investor emotions which may be fed by media outlets. Longer-term results are more about the numbers than emotion. Your financial plan should be driven by your goals, priorities, and needs. After your priorities have been identified, then and only then, should you attempt to identify the rate of return you will need to accomplish your goals and where your money should be invested.
If your focus is on the short-term or making a quick profit and you think the stock market is the place to be, you could be considered a “speculator.” In the short-term, the stock market may possibly be a place for quick profits but losses may also quickly arrive. However, long-term, stock market returns, while not guaranteed, are far more predictable. While there are no guarantees, serious, patient, disciplined investors in the stock market are often and predictably rewarded. Again, no guarantees. Time-in-the-market is far more important than timing-the-market.
Call my office in Escondido if you have questions about your financial plan or investments. “A goal without a plan is just a wish.” Antoine de Saint-Exupery.
*Investment Advisory Representative and Registered Representative of, and Securities and Investment advisory services offered through Voya Financial Advisors, Inc. (member SIPC)
The views and opinions expressed are those of the author, and the information should not be construed as individual investment advice, or as the opinion(s) of Voya Financial Advisors.