The chart that explains 2020's crazy stock market: Morning Brief

Myles Udland

·Head of News

Updated Wed, Dec 30, 2020, 2:54 AM4 min read

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Wednesday, December 30, 2020

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It’s all about earnings expectations.

2020 has been an interesting year in the stock market.

And as we wrap up the year, there is one simple question that lingers over the story of 2020: “Why have stocks gone up so much?”

Through Tuesday’s close, the S&P 500 (^GSPC) is up 15% this year and more than 60% from the March 23 lows. The Nasdaq (^IXIC) has done quite a bit better, rising 42% since January 1 and more than 85% since March 23.

There are, of course, many ways to answer this question.

Some of which are complicated and all of which are contested.

Each pocket of the market — be it a “stay at home” play like Zoom (ZM) or Peloton (PTON) or a “re-opening play” like airlines or Airbnb (ABNB) — might have a story that coheres on its own. But seeing Congress pass its second emergency stimulus package of the year and debate whether to send out $600 or $2,000 checks to most Americans doesn’t exactly scream “record high stock prices.”

Here at the Morning Brief we like to keep things simple.

And the simplest explanation for why stocks went up is that expectations for 2021 kept getting better.

As we see in the chart below, the market’s bottom coincides with a turnaround in earnings expectations for 2021. A turnaround that has not yet leveled out.

The rally in stocks this year might seem inexplicable, but the surge in earnings expectations for next year is the simplest explanation for what's been driving the markets this year. (Source: FactSet)

Stock prices can be driven by many factors — expectations for an acquisition, the involvement of an activist investor, a post on r/wallstreetbets, and so on — but each of these drivers are, in the end, a function of a company’s profits and what investors are willing to pay for them.

As we can see from FactSet’s chart, stocks and earnings expectations fell off a cliff in the spring. And then as forecasts for next year bottomed and then started turning around so too did the market itself.

In contrast, the 29% rise in the S&P 500 seen in 2019 was largely a function of multiple expansion. Valuations rose as interest rates fell last year, pushing up stock prices even in the absence of any earnings growth.

And so while the market’s current valuation may give some investors pause, the market’s rally this year has been in response to an improved outlook in corporate fundamentals.

We’ve written about expectations that operating leverage will boost profits next year, about why valuations don’t have to “normalize” at any level, and how interest rates impact these valuations.

All of which have a place in helping build a complete picture of what’s driving markets. As do animal spirits, the surge in retail traders, and the aforementioned fiscal stimulus.

But the one story that backs up all other efforts to explain the market’s behavior in 2020 is that investors see brighter days ahead for corporate profits. Everything else is a complement.

By Myles Udland, reporter and anchor for Yahoo Finance Live. Follow him at @MylesUdland

What to watch today

Economy

8:30 a.m. ET: Wholesales inventories, month-over-month, November preliminary (0.7% expected, 1.1% in October)
8:30 a.m. ET: Advance Goods Trade Balance, November (-$81.5 billion expected, -$80.3 billion in October)
9:45 a.m. ET: MNI Chicago PMI, December (56.5 expected, 58.2 in November)
10:00 a.m. ET: Pending Home Sales month-over-month, November (0.0% expected, -1.1% in October)

Earnings