The Meaning of Lower Corporate Earnings

earningsFew things go up forever, and corporate earnings are no exception. Earnings season began this week as companies started reporting their performance for the start of 2015, and American companies’ earnings are expected to decline compared to the same period last year. Should you be worried that this decline heralds the end of the bull market in stocks that’s lasted since the end of the financial crisis?

The short answer is “not too much.” There’s always some variation in earnings from one quarter to the next, not only for individual companies but also for the stock market as a whole. Such variation even occurs during long periods of stock market gains (such as the current one): there were a couple quarters in 2012 where earnings declined, and US stocks proceeded to soar in 2013.

This quarter’s projected earnings dip may also be largely the result of transient factors. The recent rise in the value of the US dollar against foreign currencies has hurt American exporters by making their products more expensive overseas, and the plunge in the oil price has hurt energy companies. If these trends reverse, or if companies adjust their strategies to adapt to the stronger dollar and cheaper oil price, earnings could bounce back.

That being said, lower earnings aren’t completely benign. Most valuation metrics indicate that US stocks are slightly overvalued by historical standards, meaning that either earnings growth needs to accelerate or that future stock market returns will be lower than average. The earnings slowdown suggests that the second outcome may be more likely, and investors should reduce their expectations about the medium-term returns that they’re likely to get from US stocks.