One piece of evidence to suggest that a widening gap between these earnings measures is not a precursor of a market downturn is that the gap widened to above-average levels in 2012, ahead of the powerful 2013 stock market rally when the S&P 500 rose 30%; and 2014 was another double-digit year for the S&P 500.
A jump in the gap in late 1991 was another false signal, as 1992 and 1993 were both solid years for stocks after a nearly 30% gain for the S&P 500 in 1991. We do not have many periods for comparison, but we have enough to be skeptical of the current earnings gap as a signal of major market weakness ahead.
Bottom line, these periods of divergent earnings measures have had clear causes that have been unrelated to the causes of the market downturns. They reflect reactions to downturns, not precursors of them. We continue to expect an earnings rebound in the second half of the year and for the earnings gap to narrow as the energy sector continues to heal.
Conclusion
We do not believe market participants should worry about the gap between GAAP earnings and operating earnings. The gap today is largely energy driven and not indicative of a broader earnings quality problem, in our view. Analysis of prior periods with similar gaps reveals these gaps were largely reactions to downturns, not precursors of them. We see little in the earnings data across the broad market that might lead to a broader market downturn.
Burt White is chief financial officer for LPL Financial.