A person might think that if inflation started to increase, it might be bad for stock prices.
And if you saw the stock market’s reaction after the Consumer Price Index (CPI) for January jumped 0.5% and is back at 3%, you might’ve thought “Well there you go, inflation is bad for stocks…”
Futures contracts for the Dow Jones Industrials Average (DJIA) plunged over 400 points immediately after the CPI report was released…which seemed to send a pretty clear message.
No doubt traders were already on edge after Fed Chair Jerome Powell told Congress yesterday that the job on inflation was not done and that the Fed was in no hurry to cut interest rates. Those comments alone changed the conversation from “maybe there will be three rate cuts this year” to “maybe there will only be one.”
But a funny thing happened on the way to today’s market rout…
Stocks started to rally.
By 1 pm when I was writing, the Dow had cut its loss by more than 50%. The NASDAQ had moved into the green…
The reason is pretty simple: earnings are more important for stock prices than one month’s inflation data. And earnings are cooking…
Bullish Earnings
Coming into this earnings season, analysts were expecting earnings per share for the companies of the S&P 500 to report earnings growth of 7.3%. So far, reporting companies that are enjoying 12.5% year-over-year earnings growth.
That’s huge. And for perspective, it's the biggest year-over-year gain for Q4 earnings since 2021 – the year after the pandemic.
Interestingly though, the companies of the S&P 500 are beating revenue at below-average rates.
So the question is: how do you take in proportionately less revenue and grow profits?
One way a company can earn higher profits on less revenue is via share buybacks. The formula for earnings per share (EPS) is net income divided by shares outstanding equals earnings per share.
If you lower the divisor with share buybacks, you get a higher EPS number.
Between September 2023 and September 2024, the companies of the S&P 500 bought back $918 billion worth of stock. That’s a lot for sure. But the total value of the S&P 500 is just over $50 trillion.
Share buybacks totaled less than 2% of all shares outstanding, which is not enough to account for earnings growth with respect to revenue.
The other way to increase earnings per share beyond revenue growth is to raise your profit margins. In other words, simply raise your own selling prices faster than your costs are rising.
A lot of people may not like it, but the fact is that a little inflation is good for stock prices!
Cheers,
Briton Ryle
Chief Investment Strategist
Outsider Club
X/Twitter: https://twitter.com/BritonRyle
You Might Also Like:
The Gains Keep Coming
https://www.outsiderclub.com/sorry-i-said-youd-double-your-money-in-2025-not-in-just-two-months/
Got Gold?
https://www.outsiderclub.com/gold-hit-an-all-time-high-you-buying/
The Lag-nificent 7
