When profits boom like they did in 2021, the stock market usually does well in the following year

Published Sun, Jan 16 20229:20 AM EST

Patti Domm @in/patti-domm-9224884/@pattidomm

Corporate earnings grew at an unprecedented pace in 2021, and in years with big profit gains, both the stock market and earnings do well in the following year historically. The estimated 44.1% growth in S & P 500 operating earnings per share in 2021 was the highest of any year going back to 1988, the first year comparable data was available, according to Sam Stovall, chief investment strategist at CFRA. Stovall said in the 10 years of highest profit growth, when earnings grew between 15.5% and 39.9%, stocks were higher 70% of the time in the following year and gained an average 12.5%. Earnings growth averaged 13.1% in those 10 years following, and revenue growth averaged 7.9%. "The conclusion is that good years follow great years. Things just don't fall off a cliff after good years," he said. "They tend to persist in the subsequent year. It doesn't mean that volatility cannot be elevated, but in the end you typically end up having good years." Stovall said many of the years with super strong earnings growth followed a bigger downturn, and there was not bigger drop than the pandemic induced recession in 2020. "If you start from a very low base, you typically have a good or pretty reliable recovery in the subsequent year," Stovall said. The second largest earnings growth was in 2010, when it jumped 39.9%, but that year was followed by a year where the S & P 500 was unchanged. The third largest growth year was in 1993 with a 28.9% gain, but the S & P 500 lost 2% the next year. "The one thing this data shows us is there's no guarantee that 2022 is going to be a good year," he said. Revenue growth was also strong in 2021, and the expected 14.5% gain was the strongest going back to the 1970s, Stovall notes. The decade of the 1970s was not a good one for stocks. "We started the decade with a year-over-year change in headline CPI at 5.3%. We ended the decade at 12.4%," he said. The Federal Reserve ultimately raised interest rates sharply at the end of the decade. Inflation in the 1970s was the result of a perfect storm of factors. "There was the debt to pay from the Vietnam war; the Arab oil embargo and you had the rise in unions," said Stovall. Stovall said there's a lesson to investors who are looking at the impact of inflation on the stock market. The sectors that did best in the 1970s were energy, utilities and materials. "Whenever inflation is high, those sectors that are more closely linked to commodities tend to outperform, such as materials and energy," he said. "Those growth sectors like consumer discretionary and technology can be more adversely impacted by higher interest rates."

A Wall Street subway station near the New York Stock Exchange (NYSE) in New York, on Monday, Jan. 3, 2022.

Michael Nagle | Bloomberg | Getty Images

Corporate earnings grew at an unprecedented pace in 2021, and in years with big profit gains, both the stock market and earnings do well in the following year historically.