S&P 500 Earnings Above Or Below Trend?

One market factor frequently mentioned regarding current S&P 500 earnings is they are far above historical trend. An example is from a recent article on the Zero Hedge website titled, Why Stock Prices Are More Stretched Than You Think: A Tale Of 3 P/E Multiples. A common discussion then leads to commentary that earnings will revert to their trend and in this discussion that means a decline in earnings. The earnings chart referenced in this commentary is the one below (updated 8/18/2013). As can be seen in the below chart earnings are above their long term [exponential] trend line. However, the below chart [is using an arithmetic scale on the y-axis] does not properly account for the percentage change in earnings. The Zero Hedge author's technical notes can be found here.

As can be seen in this next chart that displays earnings using a logarithmic scale, earnings are actually below their long term trend line. With a logarithmic scale [on the y-axis], the distance on the chart from $10 to $20 is the same as $100 to $200. The percentage move in both cases is the same and if one is looking at earnings growth, using a logarithmic scale is important.

Nearing the end of Q2 earnings reporting season, we would like to see a higher rate of growth in company earnings. However, Q2 earnings are expected to increase 4.7% for the quarter and this is higher than the 2.9% expected prior to the Q2 earnings season. Additionally, Thomson Reuters reports 67% of companies beat earnings expectations which is higher than the long term average of 63%. From a revenue perspective, 53% beat revenue expectations, below the 61% long term average, but higher than the 48% average over the past four quarters.

For investors then, when evaluating charts, pay attention to the scale being utilized in the chart graphic.

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