Today’s price/earnings divergence … Mag 7 earnings forecasts … where do you invest in AI today? … trading heightened emotions during Trump’s first 100 days In the long run, the strength (or weakness) of earnings drives stock prices. To see what this looks like, below is a chart dating to 1945 comparing the S&P’s price to its trailing 12-month operating earnings. Notice two things… First, over the long-term, these two lines have an amazingly strong correlation. This underscores our point: In the long-run, earnings drive stock prices. Second, notice how the S&P’s earnings line (in blue) is smoother than the S&P’s price line (in green). Though price bounces all around, it always eventually returns to its earnings line, a bit like a magnet. 
The higher volatility of the green price line reflects the influence of investor sentiment. In bullish periods, excited investors bid up prices well above a level that earnings would warrant. Conversely, when bears rule the day, despondent investors avoid stocks, resulting in prices that vastly undershoot levels that earnings would suggest are appropriate. | Recommended Link | | | | With Trump’s aggressive policies AND quantum leaps in AI all hitting at once, we are now sitting in the eye of the largest, most volatile storm to ever hit the stock market. Many will lose big. But for those who prepare, it could be the greatest wealth-building moment in history. Jeff Clark, a 40-year trading veteran, has a time-tested strategy that thrives in chaotic times. His gains speak for themselves: 238% on Citibank in 2 days, 186% on GDX in 8 days, 144% on Disney in 6 days. Now, he’s revealing how you can use this same strategy to turn Trump’s honeymoon period into massive profit opportunities. Stream the event replay now and get ready. |  | | So, where are we today in this dance between price and earnings? Below, we look at the S&P’s price (this time in black) juxtaposed against its earnings (in green) over the last 15 years. You’re going to see a loose parallel until about 2023, at which point the S&P’s price explodes higher, far outpacing earnings growth. We’re now at the widest relative divergence since the Pandemic recovery. 
Now, look at the chart above again and notice what happened in the past when price and earnings diverged – at some point, they always reconverged. Elevated prices didn’t always have to fall too much for this reconvergence. Sometimes earnings jumped higher beneath price, closing the size of their divergence in a healthy way. Other times, elevated prices had farther to fall because earnings weren’t as supportive in their climb. In these cases, the process of convergence was more painful. Finally, sometimes, earnings soared above price, and price enjoyed years of solid growth as they caught up (this isn’t our situation today). This leaves us with the obvious question as we enter earnings season… Will earnings leap higher to support the S&P’s elevated price? Or will earnings disappoint, resulting in the S&P’s price falling as today’s divergence eventually resolves itself? How earnings are looking at we get into the heart of Q4 earnings season It’s early in this earnings season, but so far, the results have been strong. But there’s far more happening under the surface. As has been the case for the last several years, we’re seeing a discrepancy between Big Tech earnings expectations and “everything else.” Here’s FactSet, the go-to earnings data analytics group used by the pros: Overall, three of the companies in the “Magnificent 7” are projected to be among the top 10 contributors to year-over-year earnings growth for the S&P 500 for Q4 2024: NVIDIA, Amazon.com, and Alphabet… In aggregate, the “Magnificent 7” companies are expected to report year-over-year earnings growth of 21.7% for the fourth quarter. Excluding these seven companies, the blended (combines actual and estimated results) earnings growth rate for the remaining 493 companies in the S&P 500 would be 9.7% for Q4 2024. Now, 9.7% growth for the remaining 493 companies is good on a relative basis. In fact, it would be the highest earnings growth rate since Q2 2022. That said, it’s still less than half of what’s expected from the Magnificent 7. So, does this mean that investors would be wise to load up even more on Mag 7 holdings? After all, the Mag 7 companies remain the biggest allocators toward AI technologies, and one of Trump’s primary focuses in his second term is American dominance of AI. Our macro expert Eric Fry urges investors to think twice. The headwinds facing the Mag 7 stocks Let’s jump to Eric’s January issue of Investment Report: As 2025 proceeds, I expect the richly valued Mag 7 stocks to lose some of their luster. Two main factors will cause this relative weakness. The first is simply valuation. As a group, the Mag 7 stocks are trading for a princely 37 times earnings, which is 40% higher than the near-record valuation of the S&P 500. Although richly valued stocks can maintain their premium prices for a long time, they usually struggle to do so. All else being equal, these high valuations will create a headwind to additional share price gains. For additional perspective, as you can see below, investors have already cannonballed into the Mag 7 stocks to such a degree that their collective market cap as a percentage of the S&P 500 is at record highs. According to analyst Charlie Bilello, over a third of the S&P 500 is now concentrated in the Mag 7 stocks. That’s up from a fifth of the index two years ago. 
This doesn’t mean the Mag 7 stocks can’t keep climbing from here, but to do so in a healthy, sustainable way – meaning, based on earnings, not sentiment – will require fantastic earnings performances. Now, daunting as it is, that could happen. But this dovetails us into the second challenge Eric sees: The second factor weighing on the Mag 7 stocks is the soaring cost of AI leadership. During the last few years, the Mag 7 companies have been reaping the bounty of their past investments in product development. But now with the arrival of AI, they must embark on a new era of massive investment. Collectively, the major tech companies are spending hundreds of billions of dollars to develop leading-edge AI capabilities. This monstrous investment imperative could stifle their profit growth and hinder free cash flow generation. Eric isn’t alone in recognizing this risk. Here’s Reuters from last fall: Microsoft and Meta both said on Wednesday their capital expenses were growing due to their AI investments. Alphabet reported on Tuesday that these expenditures would remain elevated, while Amazon said they would increase the rest of the year and into 2025. The extensive capital spending could threaten fat margins at these companies, and pressure on profitability is likely to spook investors. None of this means you need to immediately bail on your Mag 7 holdings. But checking your growth assumptions would be wise. And a case-by-case analysis of the “price/earnings” divergence we looked at earlier would be smart. The wider the divergence, the more risk you’re accepting. Equally important is to know exactly when/why you might sell your Mag 7 holdings if they begin to disappoint (we’ll cover this in a different Digest, but I’m looking at you, Apple investors). | Recommended Link | | | | Bill Gates calls it: “The most transformative technology any of us will see in our lifetimes.” Eric Fry agrees, saying it’s far more advanced than anything today… including AI. But he also warns it could send millions of Americans into poverty. Take these 3 steps to prepare. |  | | But while compressing profit margins could be a headwind for the Mag 7 companies, Eric believes AI will create margin expansion for different companies that utilize AI effectively Back to Eric: Because corporate profit margins are close to record levels already, predicting even fatter margins is, mathematically speaking, a bad bet, especially because I expect profit margins at the Mag 7 stocks to come under pressure. But that’s the bet I’m making. Currently, S&P 500 Index profit margins are hanging around the 13.3%-level, which is well above the 30-year average of 9.5%. But I’m looking for margins to surpass the record-high 14%-level that they hit in mid-2021. AI will power most of that margin expansion. To find these prospective winners, Eric has been looking for companies that are applying AI effectively. This is different than the first phase of AI, in which the companies that enabled AI (think Nvidia) were the market’s biggest winners. Back to Eric: Unlike the AI enablers, [AI appliers] are not at the forefront of producing the material needed to create AI. Instead, they are employing AI technology within their own products and services. AI appliers are everywhere… and growing by the day. That universe includes companies as diverse as beauty-products purveyor Coty Inc.(COTY), gold and copper explorer Ivanhoe Electric Inc. (IE), and industrial-solutions provider Rockwell Automation Inc. (ROK). Clearly, many of these companies operate in niches that are not normally associated with technology. So, they are still lying low. For more of the non-Mag-7 AI plays that Eric likes today, check out his free presentation on the 1,000-day countdown to artificial general intelligence. It’s a great starting point for how to invest in AI today, yet with an awareness of stretched valuations and the importance of earnings strength. At a minimum, be aware of the cavernous divergence between price and earnings today. History tells us that eventually, these variables will reconverge. Make sure you’re prepared for what that could mean if falling prices is the primary driver of that reconvergence. Switching gears, though earnings drive stock prices in the long-term, in the short-term, emotions rule the day And emotional investing is exactly what master trader Jeff Clark sees coming in these first 100 days of Trump’s new administration. But for pro traders like Jeff, “emotions” equals “profits.” He dove into this, and far more, earlier today in his presentation, The Most Profitable 100 Days of Your Life. From Jeff: Short-term stock price movements have more to do with emotions than any sort of fundamental factors. Think about it… The S&P 500 doesn’t move dramatically up or down in a day because business conditions changed suddenly. The movements happen because investors’ emotions changed. They got more optimistic or pessimistic. And it’s those shifts in emotions that create the short-term movements we’ve come to call “volatility.” We’ve never had a president who was more adept at evoking emotions than the one who took the oath on Monday. Love him or hate him, President Donald Trump – in every speech, posting on Truth Social, and tweet – stirs up emotions. Those emotions work their way into stock prices and create the sort of volatility that traders can take advantage of. Jeff believes emotions will be so influential on stock prices over the next 100 days that each week is likely to bring a new trade with 100%-returning potential. Stepping back, for newer Digest readers, Jeff is a 40+ year trading veteran with more than 1,000 winning trades under his belt. His years in the business have also shaped him into a fantastic teacher. And this afternoon, he detailed the specific trading approach that he’s confident will benefit from Trump-related volatility here in Q1. From Jeff: With Trumps’s focus on deregulating and cutting taxes… the backing of billionaires… his business mindset… and his “no holds barred” mentality that throws world markets into a loop on a dime… you can see how this is setting up to be the most volatile period in our lifetimes. But “most volatile,” to me, means “most profitable.” If you missed the presentation, you can catch a free replay right here. Even if you’re not sure you want to trade these first 100 days under Trump, feel free to tune in simply to see how Jeff is sizing up Trump’s impact on the markets and which sectors he believes will see the biggest fireworks. We’ll keep you updated on Mag 7 earnings, the S&P’s price/earnings divergence, and Trump-based trading opportunities from Jeff here in the Digest. Have a good evening, Jeff Remsburg | 
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