Legendary stock picker Peter Lynch made a remarkably prescient market observation in 1994.

One version of this post was originally published on TKer.co.

Peter Lynch, the legendary stock picker who ran Fidelity’s beating the market Magellan Fund for 13 years, made a prophetic observation in a speech delivered to the National Press Club on October 7, 1994.

It comes from the 38 minute mark of this video (via @DividendGrowth):

Some event will come out of left field and the market will go down or up. Volatility will occur. The markets will continue to have these ups and downs. … Core corporate earnings have grown about 8% a year historically. So corporate profits double roughly every nine years. The stock market should double every nine years. So I think the market is around 3800 today, or 3700, I’m pretty sure the next 3800 is going to go up; it won’t be down. The next 500 points, the next 600 points, I don’t know which way it’s going to go. So the market should double in the next eight or nine years. They will double again in eight or nine years after that. Because earnings are up 8% a year, and stocks will follow. That’s all about it.

Peter Lynch (Source: CSPAN)
Peter Lynch (source: CSPAN)

When he says “the market,” Lynch is referring to the Dow Jones Industrial Average, which closed in 3,797 the day he gave the talk.

Add that to an 8% growth rate over 27.5 years, which would take you to today, and you get 31,520.

The Dow closed Friday at 34,861, which is pretty close. For context, a 7% growth rate would have taken you to 24,405 and a 9% growth rate would have taken you to 40,613.

If you were to do this exercise with the S&P 500, which closed at 455 on the day of Lynch’s talk, then you would get 3,778 assuming a compound annual growth rate of 8%. The S&P closed Friday at 4,543. (A rate of 9% would have taken you to 4,867.)

According to S&P Dow Jones Indices, earnings per share (EPS) for the S&P 500 was $30.11 for the 12 months ending in the third quarter of 1994, around the time Lynch made that speech. If you add that up by 8% over 27.5 years, you’d get $250. S&P Dow Jones Indices estimates that EPS for the 12 months ending March 2022 was actually $211, which is close. (They estimate the S&P EPS to be $246 in 2023.)

Lynch was not predicting the precise point of the market in March 2022. He was talking about the trend of the markets over long-term periods while acknowledging short-term volatility. If he allows you some margin of error to account for unpredictable short-term swings, then he will be able to better appreciate how his thoughts speak to some fundamental market truths that we often talk about here at TKer.

I think three elements of what Lynch said are critical for investors to understand.

1: ‘Some event will come out of left field and the market will go down or up. Volatility will occur.

This relates to TKer Stock Market Truth No. 8: “The most destabilizing risks are those that people do not talk about”.

Russia’s invasion of Ukraine It’s a good example. For investors, a conflict between Russia and Ukraine it had not been a concern, so the markets were not ready for it. This would explain why stocks entered a deep correction amid the initial news and the buildup.

With these types of contingencies, prices will swing wildly as the markets digest every positive and negative development as the situation develops.

This contrasts with the risks that everyone has been talking about, such as inflation and tighter monetary policy. These risks had investors worried for months before those fears were confirmed, and the actual news ultimately had a limited effect on market volatility.

2: ‘I’m pretty sure the next 3,800 points will be up; it won’t be down. The next 500 points, the next 600 points, I don’t know which way it’s going to go.’

Over time, the biggest moves in the stock market will be to the upside (which relates to TKer Stock Market Truth No. 4), and the long game is undefeated (which is TKer Stock Market Truth No. 1.) But you can certainly quit short-term (TKer Stock Market Truth No. 2).

As we frequently discuss here at TKer, big sales are actually quite normal. The S&P 500 experiences an average maximum drawdown (ie, the highest intra-year liquidation) of 14% per year.

For what it’s worth, the current market correction has seen the S&P 500 drop 12% from its 2022 high, which is less bad than average.

Lynch’s comment speaks to the advantage of a long-term investment horizon, which is a valuable advantage that most investors have.

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3: ‘Earnings are up 8% a year, and stocks will follow. That’s all about it.’

Historically, the stock market has generally gone up because earnings have generally gone up. That is because earnings are the most important driver of stock priceswhich TKer Stock Market Truth No. 5.

Check out this chart of S&P 500 earnings since 1986, courtesy of Yardeni Research. It’s on a logarithmic scale, which smooths the curve you get when growth accumulates at a constant rate over time.

There is some short-term noise. But with time, earnings have been going up and to the right

Jurrien Timmer, director of global macro at Fidelity Investments, recently shared a chart showing the close relationship between earnings and stock prices.

Stock prices are on the y-axis, accompanied by earnings on the x-axis. The data goes back to 1871. The r-squared of 0.9686 in this linear regression is very close to 1, which means that earnings explain very well how stock prices behave.

In other words, stocks go where profits go.

“That’s all there is to it,” Lynch said.

More from TKer:

rear view mirror 🪞

📈 stock rally: The S&P 500 rose 1.8% last week. It is now up 8.9% from the March 8 closing low of 4,170, but is still down 4.7% from the start of the year. To learn more about big rallies amid market crashes, read is and is.

📈 US economic growth accelerates: The S&P Global Flash US PMI, an index of private sector activity, rose to an 8-month high of 58.5 in March. (Note: any reading above 50 indicates expansion). From S&P Global Chief Business Economist Chris Williamson: “The pace of US economic growth from growing concern over the Ukraine War. Output in both manufacturing and services rose at a rate not seen since last June with new business inflows rising at a rate not seen since the strong rebound in the economy seen in the second quarter of last year.”

🧳 Lowest jobless claims in decades: initial claims for unemployment insurance benefits are at the lowest level since September 6, 1969, with the last weekly count of 187,000. For more on labor market strength, read is.

😤 But consumer sentiment turns sour: Despite Strong Labor Market Outlook, Sentiment Remains Weak — largely due to inflation. the University of Michigan consumer sentiment index fell to 59.4 in March, its lowest level since August 2011. From the survey’s chief economist, Richard Curtin: “Inflation was mentioned throughout the survey, whether the questions were about personal finances, the outlook for the economy, or assessments of buying conditions. When asked to explain changes in their finances in their own words, more consumers mentioned reduced living standards due to rising inflation than at any other time except during the two worst recessions in the last fifty years: March 1979 to April 1981, and May to October 2008. In addition, 32% of all consumers expected their overall financial position to worsen in the next year, the highest level recorded since surveys began in the middle of the decade. of 1940.“ For more on sentiment, read is.

🛍 But consumers are still spending: Despite inflationary pressures and other concerns, consumers continue to spend. Nike, General Mills and Darden Restaurants, parent of Olive Garden, confirmed strong sales for the three months ending in February. To learn more about what drives spending, read is.

🏘 Mortgage rates are rising: The average 30-year fixed-rate mortgage had a rate of 4.42%, the highest since January 2019. From freddy mac: “Rising inflation, growing geopolitical uncertainty and Federal Reserve actions are raising rates and weakening the purchasing power of consumers. In short, rising mortgage rates, combined with continued home price appreciation, are driving up monthly mortgage payments and rapidly affecting homebuyers’ ability to keep up with the market.”

📉 Pending home sales fall: The pending home sales index fell 4.1% in February. “Pending transactions decreased in February mainly due to the low number of homes for sale,” said Lawrence Yun, chief economist at the National Association of Realtors, said on friday. “Buyer demand is still strong, but it’s as simple as ‘you can’t buy what isn’t for sale.'”

🏛 The Fed is ready to be aggressive: In his effort to cool inflation, Fed Chairman Jerome Powell said the central bank is prepared to turn aggressive with a tighter monetary policy. Here’s Brian Cheung of Yahoo Finance: “Powell joked that ‘nothing’ could stop the Fed from raising interest rates twice (50 basis points, instead of 25 basis points) at the bank’s next policy-setting meeting center in the first week of May”. . A 50 basis point hike has not been made in a single meeting since 2000, but Powell stressed that the Fed is not committed to a specific path. For more on tighter monetary policy, read is and is.

Along the way 🛣

The highlight of the week will be Friday’s March jobs report. Economists estimate that US employers added 475,000 jobs during the month. From Wells Fargo economists: “Job growth has been surprisingly strong and constant in recent months, with nonfarm payrolls growing an average of 582K in the last three months. The resilient pace of hiring has been facilitated by workers returning to the workforce as restrictions around COVID have eased and financial needs have increased.”

One version of this post was originally published on TKer.co.

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