Charting the Market: Fundamentals, Not Narratives, Now Drive Stock Performance

By:

Head of SPDR Americas Research

  • Fundamentals are in focus as profitable stocks have outperformed unprofitable stocks for 11 straight months
  • In every sector, profitable stocks have outperformed unprofitable stocks this year
  • Price is a big factor as inexpensive profitable stocks have outperformed expensive ones in 2022

There was a time when rally narratives drove short-term performance. Back when stimulus programs fueled the recovery from the pandemic, investors focused on the “next new big thing” rather than whether a firm generated positive free cash flow. As a result, unprofitable stocks had outsized returns, outperforming profitable firms by 43 percentage points in the year following the markets bottom.1

All that has changed in the past few months, as sentiment has become uneven and monetary policy has begun to change the math around the narrative darlings. Rising rates have increased the discount rate that many of these high growth firms potential future cash flows were being discounted at. And that’s led to lower prices.

Higher real rates have normalized the opportunity cost as well. When real rates were negative, investing in a stock that generated no cash flow but had projections of robust future growth was more appealing than owning cash. Both investments burned money in the short term, but the latter offered upside potential. Today’s positive real rates change that opportunity cost. Now, only the unprofitable stock burns cash in the short term.

The performance trends of profitable and unprofitable stocks underscore how the market now trades more on fundamentals than narratives. In this Charting the Market, I will explore what this means for portfolios.

Profitable and Unprofitable Stocks Diverge

As the broader equity market has fallen, performance between firms that make money versus those that do not has diverged.

This analysis is based on equal-weighted portfolios formed from constituents within the Russell 3000 Index, partitioned by their trailing 12-month earnings-per-share (EPS). Profitable stocks are firms with positive EPS; unprofitable firms have negative EPS. Using an equal-weighted construct for this analysis removes any size bias of large versus small as the latter typically has more unprofitable firms (17% versus 46%, respectively).2

The chart below shows the performance over the past year of these two profit-based groupings. Profitable stocks have outpaced their unprofitable peers since June 2021. The turn in trend during late spring is an interesting inflection point.

Real rates bottomed out in mid-July and have increased ever since.3 Nominal rates did the same, doubling since then (3.0% versus 1.5% in July 2021) with large increases in 2022.4 Given those rate moves, the biggest differences in performance have occurred this year.

Profitable Versus Unprofitable Stock Monthly Performance

Profitable Versus Unprofitable Stock Monthly Performance

With strong performance every month, profitable stocks have outperformed unprofitable ones by 23% this year. In fact, profitable firms also have outpaced the broader market (-12.7%) as well as the average stock return (-15.4%) this year.

Profitable Versus Unprofitable Stock Year-to-Date Performance

Profitable Versus Unprofitable Stock Year-to-Date Performance

But a straight-line average can be limiting. Separating profitability by quintiles can be more informative. The chart below shows that when broken out by quintiles of profitability, the most profitable stocks have had the strongest performance. The returns also worsen monotonically when moving down the quintile spectrum — underscoring the strength of this trend.

Average Return by Profitability Quintile

Average Return by Profitability Quintile

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Originally Posted June 10, 2022 – Charting the Market: Fundamentals, Not Narratives, Now Drive Stock Performance

Footnotes

1 Bloomberg Finance L.P. as of June 8, 2022, based on stocks in the Russell 3000 Index with negative earnings-per-share versus those positive earnings-per-share from April 30, 2020, to April 30, 2021.
2 Bloomberg Finance L.P. as of June 8, 2022, based on the stocks in the Russell 1000 Index (Large Caps) and the Russell 2000 Index (Small Caps).
3 Bloomberg Finance L.P. as of June 8, 2022, based on the yield on the US 10 Year Treasury Inflation Protected Bond.
4 Bloomberg Finance L.P. as of June 8, 2022, based on the US 10 Year Yield.
5 Bloomberg Finance L.P. as of June 8, 2022, based on stocks in the Russell 3000 Index.
6 Bloomberg Finance L.P. as of June 8, 2022, based on the return of the S&P 500 Energy Sector Index.
7 Bloomberg Finance L.P. as of June 8, 2022, based on stocks in the Russell 3000 Index within the Consumer Staples Sector.
8 Bloomberg Finance L.P. as of June 8, 2022, based on stocks in the Russell 3000 Index.
9 Bloomberg Finance L.P. as of June 8, 2022, based on stocks in the Russell 3000 Index.
10 Based on the underlying holdings of funds classified by SPDR Americas Research as Broad Innovation funds within the thematic ETF marketplace as of June 8, 2022, per Bloomberg Finance L.P. data and SPDR Americas Research calculations.
11 Based on the underlying holdings of funds classified by SPDR Americas Research as Broad Innovation funds within the thematic ETF marketplace as of June 8, 2022, per Bloomberg Finance L.P. data and SPDR Americas Research calculations.
12 FactSet, as of June 8, 2022. Based on consensus analyst estimates.
13 “The Cash Burning Question”, Barclays Equity Research June7, 2022.

Glossary

Russell 3000 Index
The Russell 3000 Index is composed of 3000 large US companies, as determined by market capitalization. This portfolio of Securities represents approximately 98% of the investable U.S. equity market.

S&P 500 Energy Sector Index
The S&P 500 Energy Sector Index is the GICS Level 1 sector index of stocks within the sector in the S&P 500 Index.

Global Industry Classification Standard (GICS)
The Global Industry Classification Standard (GICS) is a method for assigning companies to a specific economic sector and industry group that best defines its business operations.

Disclosure

The views expressed in this material are the views of the SPDR Research and Strategy team through the period ended June 8, 2022, and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.

The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor.

Unless otherwise noted, all data and statistical information were obtained from Bloomberg Finance, L.P. and SSGA as of June 8, 2022. Data in tables have been rounded to whole numbers, except for percentages, which have been rounded to the nearest tenth of a percent.

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Equity securities may fluctuate in value and can decline significantly in response to the activities of individual companies and general market and economic conditions.

Because of their narrow focus, sector investing tends to be more volatile than investments that diversify across many sectors and companies.

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