This chart is titled "Earnings vs Valuation" and shows two overlaid time series from January 1996 through what appears to be late 2024 or early 2025, based on the x-axis.
Here's a breakdown of its elements and what it's communicating:
1. What’s being plotted
Right y-axis: Trailing EPS (Earnings Per Share) growth rate (year-over-year percentage change).
Left y-axis: S&P 500 index level (logarithmic scale).
Vertical shaded bars indicate recessions (based on NBER dating).
Arrow lines mark peaks in EPS growth just before significant slowdowns or declines.
2. Key observations from the chart
A) Earnings Growth
Highly cyclical, closely tied to economic recessions (gray bars).
Sharp drops in EPS growth occurred during:
2001 recession (dot-com bust)
2008–2009 financial crisis (deepest drop, below –30%)
2020 COVID-19 recession (brief but sharp fall)
2022–? slowdown (post-pandemic, with inflation and tightening)
Peak growth periods often precede downturns (marked by arrows).
B) Stock Market Valuation (Gray Line – S&P 500)
Despite earnings volatility, the S&P 500 has trended upward over the long term (log scale shows consistent compounding).
Notable corrections align with earnings recessions:
2000–2002
2008–2009
2020 (brief)
2022 (valuation reset as rates rose)
Market doesn’t always fall when earnings slow if future growth is anticipated or rates are low (e.g., post-2010).
C) Recent Data (2022–2024)
EPS growth peaked around late 2021 / early 2022 at very high levels (~50% year-over-year, likely due to post-COVID recovery and stimulus).
Growth then slowed sharply through 2022–2023 but remained positive in late 2023 / early 2024.
S&P 500 continued rising even as EPS growth normalized — suggesting valuation expansion (P/E multiple increase) possibly due to AI optimism, easing inflation expectations, or Fed pivot hopes.
3. Interpretation & Discussion Points
Earnings cyclicality vs. market trend
Earnings are much more volatile than stock prices in the long run. The market smooths out short-term earnings shocks by looking ahead.Valuation expansion in late cycle
In recent years (2023–2024), S&P 500 kept rising despite slowing EPS growth. This implies higher P/E ratios, which can be justified by lower interest rate expectations, technological disruption (AI), or liquidity. It also raises questions about market overvaluation if earnings don’t re-accelerate.Peak growth as a signal
Chart highlights that when EPS growth peaks at very high levels (e.g., >30%), it often precedes a slowdown or recession. The 2021–2022 peak was exceptionally high due to easy comps and fiscal stimulus — the subsequent deceleration was expected.Forward-looking market
The market often bottoms before earnings trough (e.g., late 2008/early 2009 rally before earnings recovered; 2020 March low before V-shaped EPS rebound).Current context (end of chart)
EPS growth appears to be modestly positive, S&P 500 near highs — suggests market betting on a soft landing and future earnings recovery rather than an imminent recession.
4. Investment Implications
Watching EPS growth momentum can help identify cycle turns.
High valuation + decelerating earnings = potential vulnerability if macro deteriorates.
Long-term investors benefit from looking through earnings cycles, as market trend has been upward despite periodic 30%+ EPS drops.
This chart essentially tells a story of short-term earnings volatility within a long-term bullish equity trend, with recent years showing a notable disconnect between earnings growth and market performance — likely driven by liquidity, interest rates, and long-term growth expectations.
