This S&P 500 hot streak is actually a warning sign for your stocks

By Mark Hulbert

15 consecutive quarters of revenue growth for S&P 500 companies - not enough to support current prices

Corporate sales are growing at an impressive rate, but the underlying data tell a more sobering story about the U.S. stock market's future potential.

When all the companies in the S&P 500 SPX have reported second-quarter results, the benchmark index's sales per share will be 5.2% higher than a year ago, FactSet estimates. That's the highest year-over-year growth rate since the second quarter of 2022.

There's more good news. John Butters, FactSet senior earnings analyst, reports that this year's second quarter represents the 15th consecutive quarter of revenue growth for the S&P 500. That ties the period from the third quarter of 2016 through the first quarter of 2020 for the longest span of consecutive quarters of year-over-year revenue growth for the S&P 500 since 2008, when FactSet began tracking this metric.

It's important to put these numbers in perspective, since, over the long term, the S&P 500's sales per share have grown more slowly than the U.S. economy. This is illustrated in the chart above, which plots nominal U.S. GDP growth since 1954 along with S&P 500 sales per share. The former has grown at a 6.3% annualized rate, while the latter has expanded at a 5.7% rate.

Entrepreneurial capitalism

Investors have a hard time understanding why corporate sales growth should lag the economy over the longer term. While any business's sales growth may lag, sales growth for corporate America as a whole should over time equal the growth of the U.S. economy.

The reason it doesn't is because of what's known as entrepreneurial capitalism, which refers to the portion of economic growth that is not produced by publicly traded corporations. The difference can be substantial, according to Robert Arnott of Research Affiliates and William Bernstein of EfficientFrontier.com - as much as two percent annualized. In a now-famous 2003 article in the Financial Analysts Journal, they referred to this difference as the "Two Percent Dilution."

In an email, Arnott conceded that this dilution in recent years has been less than what he and Bernstein estimated two decades ago, but this is likely temporary because, according to Arnott, it was caused by "buybacks, which in turn were fueled by [the Fed's] zero interest rate policy." Bernstein agreed that dilution in future years will likely return to historical norms, since "real interest rates have [now] returned to" more more normal levels.

Future stock returns

Regardless of what future dilution actually is, this discussion has profound implications for what the U.S. stock market's long-term growth rate will be. The economy over the next decade should grow at an inflation-adjusted rate of 1.8% annualized, according to projections from the nonpartisan Congressional Budget Office. If corporate sales growth lags the economy by the same margin as over the last seven decades, sales per share will growth at a 1.2% annualized real rate. If sales growth lags the economy by the full two percentage points that Arnott and Bernstein estimate, real sales growth will be negative.

If the stock market is to grow faster than that, as most investors hope and even expect, then growth will have to come from somewhere else. But that somewhere is not clear. One way would be for corporate profit margins to expand significantly, thereby squeezing more earnings out of each dollar of sales. But, as I discussed in a column last spring, that seems unlikely across corporate America, on average. Current profit margins are already close to record highs, and history teaches us that record-high margins are more likely to narrow than expand further.

Another way that the stock market could grow faster than the economy would be for the overall market's price-to-earnings ratio to grow markedly. But that also seems unlikely, since the S&P 500's P/E ratio is already far higher than historical norms. The S&P 500's forward 12-month P/E currently is higher than in 98% of all months since 2000. As with profit margins, the lesson of history is that average P/E ratios over the next decade will most likely be lower than the current level, not higher.

The bottom line: Notwithstanding the S&P 500's record string of quarterly sales growth, the stock market's longer-term prospects are bleak.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com

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-Mark Hulbert

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08-24-24 1309ET

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