While events in Europe continue to dominate the financial press, strong corporate profits are tending to be overlooked. Unless things dramatically change during the last two months of the year, 2011 should be a record year for company profits even though the stock market is well below its all-time highs.
Those who watch the stock market closely will notice that most recent day-to-day moves in our market are based on what happened earlier in the day in Europe. Clearly, events in Europe are important for the world economy, however, for a long-term investor, corporate earnings are more significant than who is in charge of the government of Greece.
More than 80% of U.S. companies through last week have reported their earnings for the third quarter. The average increase in earnings for those companies reporting was 16% over the previous year. To put that number in context, over long periods of time, company profits tend to increase an average of 5% to 7% per year. However, during recessions, earnings growth is normally negative, so periods of double-digit gains frequently occur to make up for prior shortfalls.
Another point to consider with the good profit numbers is that our economy, despite high unemployment, is actually getting better. Consumer confidence figures may be very low, but spending is still increasing and auto sales for the last two months were near their highest levels of the year. Also, a significant portion of corporate profits is derived overseas and with the exception of several countries in Europe, most regions of the world are expanding.
Investors who are concerned about the stock market may counter that the stock market is forward looking and future earnings will not be that good. While Europe has significant debt problems, it is unlikely that their issues will cause a global recession as in 2008. Rather, Europe as a whole will likely experience anemic growth or a mild recession in 2012 but the world economy will still expand. Corporate profit growth will clearly slow from the current 16% pace in 2012, though I expect earnings to continue to expand next year.
Events in Europe will likely continue to dominate the financial news, so volatility in the stock market will remain relatively high. Greece has been in the forefront recently, but it appears that events in Italy may start to overshadow those in Greece. It is important to recognize that while the day-to-day gyrations of the market may be worrisome, as long as corporate earnings are strong, the stock market should perform reasonably well over time.