This is arguably the single most important market data for investors to focus on. The blue line shows the value of the S&P 500 index of 500 blue-chip U.S. companies, and the purple line shows the earnings—profits—per share was averaged by the 500 companies In the index dating back to 1988. Corporate earnings are the single most important determinant of stock prices.
The red markers, in the upper right corner, show that the consensus forecast of Wall Street analysts for earnings on the S&P 500 stock index, as of September 26, 2013, was for $110.18 per share for 2013 and $122.62 per share for 2014.
If the economy continues to grow, as the Fed’s staff of economists and private forecasters recently predicted it would, then corporate earnings are likely to continue on the trajectory shown. If stock prices always follow earnings, this would be good for stock prices.
The earnings forecast, which seems reasonable given the recent strength of the economy, would propel the price of the S&P 500 in 2013 and 2014 in the trajectory shown in the red square markers.
In the period of irrational exuberance, around 2000, stock prices shown in the blue line and corporate earnings shown in the purple line, did not stay correlated. The gap shows how stock prices can become disconnected from fundamentals due to human emotion. However, if you look at the relationship between the blue and purple lines now, stocks are actually trading at the low end of their historical valuation relative to earnings.
Keep in mind, the red squares are not meant as a prediction of where stocks prices will go. Unexpected events could derail stocks. But barring some major event or crisis, the trajectory of stock prices remains favorable and economic growth at the end of the second quarter appeared to support this trajectory.