In a note to clients on Friday, FactSet’s John Butters highlighted what is, forever and always, the most irrational chart in the market [see below].
The comments above and below are edited ([ ]) & abridged (…) excerpts from an article by Myles Udland (BusinessInsider.com) to provide a faster and easier read.
The green line going up is the S&P 500, which, since the beginning of the third quarter, has risen by 3.4%. The blue line going down is expected S&P 500 earnings, which, since the beginning of the third quarter, have declined 2.5%.
In a very basic way, the above chart makes no sense. Stock prices are, in theory, a broad reflection of the value of the business. The value of the business, primarily, is how much profit a company earns. As earnings fall, and particularly as earnings expectations fall — because stock prices don’t just reflect current profits, but the discounted value of future profits — one would expect stock prices to fall but, as we see, earnings are falling and stock values are rising.
…Perhaps, however, it is an analysis that calls this price and earnings action “irrational” that is the silly one because…the third quarter “marked the 16th time in the past 20 quarters in which the bottom-up EPS estimate decreased during the first two months of the quarter while the value of the index increased during the first two months of the quarter,” says Butters.
[The above] means that this chart — this irrationally yawning gap between the value of America’s 500 biggest public companies, and the profits that they are expected to earn — might not be rational or irrational. It just is.