As you can see from the chart below Wall Street is a pretty optimistic place. The lines show what analysts were estimating for corporate profits at the beginning of each year versus how they turned out. Over thirty years of tracking these numbers only twice have the S&P 500 companies delivered earnings higher than first predicted by Wall Street.
This year will probably be no exception. Since the election in November the market is up impressively. Many are quite excited about the possibilities for the Trump agenda: lower taxes, more infrastructure spending and fewer regulations.
The reality, however, is that none of this is going to happen very quickly. We have just seen how the repeal of the Affordable Care Act dissolved in rancor between the right, the left and those few still in the middle. The same will happen with tax reform. So the numbers being used for corporate profits this year, up 10% or more, are probably too ambitious.
Still however, it does not pay to be too pessimistic on Wall Street, at least not over the long term. In Las Vegas if you play the tables long enough you are guaranteed to lose. The odds are stacked against you. Long term the House always wins. On Wall Street, however, if you play long enough and play consistently, you will win. The reason is that stock prices are a function of corporate earnings. If corporate earnings increase, so will stock prices, and over ten year and longer periods, corporate profits grow and have been consistently higher. The stock market tends to go up six or seven years out of every ten.
We are pretty sure we will get a period of declining prices at some point in the future. We always have. It is the nature of the market to overshoot both on the updside and the downside. But a short term decline in prices is not the end of the world or something you can time with any great accuracy.
So Wall Street may be over estimating corporate earnings now, and it is certainly important to take this into consideration. But the global economy still looks solid in 2017.
