Indiana Trust Wealth Management
Investment Advisory Services
by Clayton T. Bill, CFA
Vice President, Director of Investment Advisory Services

  • The U.S. equity market, represented by the S&P 500 index, rose 1.4% this week.
  • It’s not the expectation of lower interest rates or a “bubble” in tech stock valuation that has pushed the US stock market to new all-time highs in recent weeks. It’s corporate earnings growth.

The stock market has notched all-time highs on multiple occasions in 2024, surpassing its previous high-water mark on January 3, 2024. Stock market valuations are bumping higher, as well.

As stocks become more expensive relative to underlying corporate earnings, theoretically, future returns are diminished as a result. The most common measure of the market’s valuation is the price-to-earnings (“P/E”) ratio, or the P/E “multiple”. The market’s P/E ratio takes the price of the market divided by one year’s corporate earnings. That figure currently stands at roughly 19 times earnings.

The theory that high P/E ratios lead to lower market returns has not held up in practice. The P/E ratio has been a poor predictor of near-term returns. While it has done better at predicting long-term performance, overall, the P/E multiple should be viewed more as a temperature check on the market rather than a definitive guidepost to future returns.

Some claim that a bubble is forming in technology stocks and that returns are being driven by nothing more than multiple expansion, which is sure to revert. Others are claiming that stocks are rising because investors expect interest rate cuts by the Federal Reserve later this year. Lower interest rates make future earnings more valuable, so lower interest rates should help stock prices, all else equal.

Perhaps the reason why stocks are climbing has a much more straightforward explanation: over time, stocks follow corporate earnings, and earnings are expected to rise in 2024 by over 10%. Earnings growth is primarily why the market has recovered and grown since 2020. The below chart from Carson Investment Research shows that almost all the market’s cumulative 58% return over the last four years is from earnings and dividend growth (the green bars), not from multiple expansion (the yellow bars):


Source: Ryan Detrick, CMT, February 8, 2024i

What might look or feel like froth on a given day or week looks much different when the lens is widened to include longer timeframes. Over time, stocks tend to follow corporate profits.

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