Insight Line—April 23, 2007

The earnings growth rate is an important determinant for individual stock performance. But, as with many factors that influence total returns at the broad market level, there are degrees of importance and one size does not fit all.

Consider the tables below, showing the percentage gain per annum of the S&P 500® Index¹ during different earnings growth scenarios since 1927. At first read, it seems investors have placed little, if any, credence in the growth rate of earnings as a bullish or bearish market indicator.

S&P 500 Gain/Annum, 3/31/1927–6/30/2007 (e)2

Y/Y Earnings Growth is:	Gain/Annum	% of time
Above 20%	2.0%	23.5
Between 5% and 20%	5.9%	30.7
Between -20% and 5%	13.1%	38.6
-20% and below	-14.8%	7.2

However, a more nuanced reading of the data and a slightly different time horizon suggests the existence of a modestly positive bias to returns when the growth rate of earnings is rising rather than falling.³

S&P 500 Gain/Annum, 3/31/1927–6/30/2005

Y/Y Earnings Growth is rising and:	Gain/Annum	% of time
Above 20%	6.5%	19.4
Between 5% and 20%	3.0%	19.4
Between -20% and 5%	14.1%	11.2
-20% and below	6.0%	2.3
Y/Y Earnings Growth is falling and:	Gain/Annum	% of time
Above 20%	-17.3%	4.1
Between 5% and 20%	9.6%	11.1
Between -20% and 5%	11.7%	28.7
-20% and below	-21.5%	5.3

Moreover, the best average returns—irrespective of a rising or falling earnings environment—arguably have existed when earnings growth falls within the range of a 20 percent decline to a 5 percent rise. In other words, a falling rate of earnings growth has not always result in a market moving to the downside. Indeed, in the current market environment, the growth rate of earnings has been declining, and the market has gone higher. How can this be?

The answer, I believe, lies in the fact that S&P 500 earnings, while indeed an important economic measure for the economy’s direction, are not necessarily analogous to the entire profit of the economy as measured in the Bureau of Economic Analysis’s (BEA) National Income and Product accounts. You see, the fact that numerous well known household names such as Mars and Cargill, as well as hundreds of thousands of privately held businesses, are not measured in the S&P 500 Index arguably gives investors the opportunity to look past the indexes to the economy as a whole.

Granted, if history is any guide, there is a point when a declining rate of earnings growth is so bad that it is really bad. Though past instances have been infrequent (see data), it nonetheless has occurred and cannot be ruled against reoccurring in the future. But, on balance I suggest the data reveals the forward-looking nature of equity investors, who have already priced in an earnings deceleration by the time it comes. Simply put, what everyone knows is not worth knowing.

¹ The Standard and Poor’s 500® Index (S&P 500) is a broad-based index, the performance of which is based on the performance of 500 widely-held common stocks chosen for market size, liquidity and industry group representation. The index does not include any expenses, fees or sales charges, that would lower performance. The index is unmanaged and should not be considered an investment. It is not possible to invest directly in an index.

² Source: Ned Davis Research, Inc. S&P 500 GAAP Earnings Growth, Chart S663, ©2007. Note, earnings growth rate are estimates for 6/30/2007.

³ “Is Earnings Growth Deceleration a Big Deal?” Chart of the Day, Ned Davis Research, Inc. ©2004, September 30, 2004.

This material has been prepared using sources of information generally believed to be reliable. No representation can be made as to its accuracy. The forecasts and opinions in this piece are not necessarily those of Van Kampen, and may not actually come to pass. Information in this report does not pertain to any Van Kampen product and is not a solicitation for any product.