By Ben Levisohn
Voters are heading to the polls today to vote for Donald Trump or Kamala Harris (or perhaps a third-party candidate). Headlines are shouting about the implications of the election for the stock market, and Barron's is here to shout right back with four things that matter more than who occupies the White House.
Earnings
It's easy to forget, but buying a stock means you're buying a piece of a company, and companies exist to make money. The more money they make -- and the faster they grow those profits -- the more investors want to own them. Of course, earnings growth is dependent on sales combined and the ability to convert them to earnings.
Those factors are one reason Nvidia is running neck and neck with Apple in the battle to be the stock market's most valuable company, despite having a fraction of the revenue of the iPhone maker. Nvidia is expected to report net income of $67.4 billion in fiscal 2025 on sales of $125.7 billion for a net margin of 53.6%; Apple reported net income of $93.7 billion in fiscal 2024 on sales of 391 billion for a net margin of 24%. Nvidia is also expected to grow earnings per share by 54%, while Apple's are expected to grow at a 21% clip, according to FactSet.
The same is true of the overall stock market, which is why the S&P 500 has been able to outperform just about every other market in the world over the past decade.
Valuations
Whether buying a stock or the stock market, investors need to decide what valuation to pay. And that valuation will depend on factors including how fast sales and earnings are growing, and on a company's margins, as well as how sustainable they may be -- and it's why Nvidia fetches 36 times 12-month forward earnings to Apple's 29.7 times.
They're also a reason the S&P 500 can trade at 21.4 times -- higher than any time outside the dot-com bubble and the Covid-era bounce -- and have no one bat an eye. "The relationship between gross margins and price-to-forward earnings is quite consistent and obvious," writes Trivariate's Adam Parker. "Valuation and margins are tied together because businesses with high gross margins have either pricing, technology moats, low capital intensity, and/or a replicability to their business model that on average means their earnings farther into the future are more achievable."
As long as those factors remain true, the S&P 500 can trade at a higher multiple than it has historically.
The Economy
Of course, earnings and multiples are dependent on the U.S. economy. If the economy is firing on all cylinders, businesses -- especially "cyclical" ones -- should be able to grow sales and profits. If there's a recession, earnings and valuation would be called into question.
Right now, the economy seems to be doing just fine. Third-quarter gross domestic product grew at a 2.8% clip, and the job market seems to be holding up okay despite October's super-weak print. Tuesday's Institute for Supply Management services Purchasing Managers' Index also came in strong.
"This is yet another sign in the economic data that the economy is not heading into a slowdown or a recession, but rather that it more likely is exiting a mild period of consolidation," writes Jefferies economy Thomas Simons.
As long as the economy can continue to grow, the S&P 500 should keep rising. But remember -- the stock market is a leading indicator. It will start to fall when it begins sniffing out economic weakness.
The Federal Reserve
The Federal Reserve does its best to keep everything in equilibrium by controlling interest rates. If the economy is too hot, it will raise rates, and sometimes quickly, as was the case in 2022. The moves helped slow down the economy and pushed down the rate of inflation, but also led to a bear market in that year. The Fed is now cutting rates as it attempts to engineer a soft landing. Lower rates also take the pressure off valuations, because they make bonds less attractive to investors, who might look to stocks as an alternative.
Of course, not everything plays out as expected.
The 10-year Treasury yield has surged since the Fed cut rates by half a point in September as the market adjusted for an economy that still looked strong and a slightly higher inflation rate. The CME FedWatch tool still puts the chances of a rate cut at 95% when the Fed announces its decision on Thursday, so it's likely policy will continue to support the S&P 500.
Write to Ben Levisohn at ben.levisohn@barrons.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
November 05, 2024 12:24 ET (17:24 GMT)
Copyright (c) 2024 Dow Jones & Company, Inc.
Comments