When it comes to corporate earnings, there actually can be too much of a good thing.
History has shown that years with particularly high profit growth, the chances are actually better that the market finishes lower. This comes about primarily when expectations get so high that even strong performance isn’t enough, and when investors get concerned that the strong earnings are indicative of an economy that is overheating.
Counterintuitive though it may seem, the pattern is important. That’s because many investors are using the strong performance on both the top and bottom lines for corporate America as the foundation for their bull market thesis.
History has shown, though, that froth comes in many forms, even profits.
“If you look at the years where earnings were up double-digits, you actually had a slightly higher probability of having a down market vs. other years, which is really quite fascinating,” said Dan Suzuki, equity and quant strategist at Bank of America Merrill Lynch.
During the bull run of 2009-17, there was a strong correlation between profit growth and the rise of the stock market indexes.