The Investment U e-Letter: Issue # 327
Thursday, April 8, 2004

Tim Hayes/Ned Davis Research - Why Big Profits Are Bad for Stocks
By Brian Hunt, Vice-President, Investment U

[Today, I've invited Investment U Vice President Brian Hunt to tell us about a great new book that exposes the myth about earnings and how they affect stock market performance. Enjoy Steve Sjuggerud, President, Investment U]

Surging profits are bad for the stock market? I couldn’t believe it but it’s true.

Buying stocks when earnings growth is slowing down sounds like a bad idea but it’s actually the best time to jump in the market according to Tim Hayes at Ned Davis Research (NDR).

You’ve probably never heard of Tim Hayes or Ned Davis Research (although we have mentioned NDR in this space before). Your financial planner probably doesn’t know them. And - chances are - 99% of the “experts” putting out stock market advice don’t know them.

That’s too bad, because the folks at Ned Davis Research do some of the best market analysis in the world and NDR’s brilliant strategist Tim Hayes has written a book called The Research Driven Investor that contains some surprising advice on investing. It’s advice that could save you a ton of money - by doing exactly the opposite of what the so-called “experts” are recommending.

Tim Hayes: CNBC’s Talking Heads Are Full of It

The experts on TV telling you to buy into the market based on big earnings growth are wrong. They haven’t done their homework. They’re just repeating what their bosses tell them - that it’s always time to buy stocks.

In The Research Driven Investor, Tim Hayes explains:

“To an armchair investor tuned into CNBC or the other sources of financial news that discuss favorable earnings news in bullish terms and unfavorable news in bearish terms, it may seem counterintuitive or illogical that rapid earnings growth is consistent with weak market performance

And it may seem equally odd that the historical record shows weak earnings growth consistent with strong market performance.”

Tim Hayes has done the homework, he’s taken time to run the numbers and it shocked me when I read his conclusion.

Hayes crunched the numbers all the way back to 1932 - and found when earnings growth (as measured by S&P 500 earnings) is strong, you make a measly 1% per year in the stock market.

During periods of negative S&P 500 earnings growth, stocks do great - earning about 15% a year.

The pattern between earnings and stock market performance seems crazy But remember: The stock market looks into the future, not the past. It’s a cliché, but the stock market is the ultimate discounting mechanism the good news of the future is already priced in.

By the time companies are reporting earnings growth of 20%, the market is already looking to the future - when earnings might slow down or decline.

Where Buffett’s Putting $36 Billion Now (Hint: Not in Stocks)

When it can’t get any worse, when the public hates stocks - that’s when buying stocks makes you big money.

Legendary investors like Warren Buffett and Sir John Templeton (yes, Templeton is so good he’s been knighted) have made fortunes by committing a lot of money to stocks when the public can’t stand the thought of buying them.

But Warren and Sir John are negative on stocks now everyone else loves them, and earnings growth, at a projected 10% for 2004, is high.

Warren Buffett has about $36 billion in cash he’s not putting into stocks - because the talking heads on CNBC are bragging about earnings And the public is pouring money into the market.

Now is a good time to remember Tim Hayes’ research and it’s always good to know what Warren Buffett is doing.

They’re both saying it’s a good time to hold lots of cash instead of lots of stocks maybe you should do the same.

Good investing,

Brian Hunt

P.S. Learn more about Ned Davis Research in Investment U issue # 249.

Related Articles:

• Ned Davis Research What The Best Analyst Is Saying Now

Investment U Archives