Traders work on the floor of the New York Stock Exchange.
Blowout earnings are forcing analysts to up estimates for 2021.
With a little more than half of companies reporting, earnings are proving to be a pleasant surprise for the trading community.
The GameStop/Robinhood fiasco is turning out to be a minor blip in the markets in the first months of 2021. The main theme that ended 2020 — the belief in the effectiveness of a vaccine —remains intact.
“The markets are advancing to new highs as Covid cases are dropping, stimulus is coming in at the higher end of expectations, and we are continuing to see very positive earnings surprises,” Nick Raich at Earnings Scout told me.
Surprises and raised earnings
Stocks are expensive. The S&P 500 is trading at 22 times 2021 earnings, historically high. For stocks to keep advancing, two things had to happen: very large earnings beats for the fourth quarter, and corporate guidance needed to be sufficiently clear that earnings estimates for Q1, 2, and 3 would keep rising.
Both of these conditions have been met. First, earnings are beating estimates by more than 17%, about five times the normal average and on a par with the third quarter. The reason: analysts have underestimated the strength of the economic recovery.
Q4 earnings: halfway point (53% reporting)
- Beating: 83%
- Earnings beat: 17.3%
- EPS growth: up 1.6%
Second, earnings surprises are now translating into higher estimates for the first and second quarters.
S&P 500: Q1 2020 earnings estimates
- Jan. 1: up 16.0%
- Today: up 20.5%
S&P 500: Q2 2020 earnings estimates
- Jan. 1: up 45.7%
- Today: up 49.9%
Analysts typically are overly optimistic and start cutting estimates as the quarter wears on, but in the second quarter the opposite has happened.
“That’s an unusual occurrence; the Street is usually cutting numbers by this point in the current quarter,” Nicholas Colas from DataTrek said in a recent note.
Technology, materials and real estate earnings have been particularly strong.
Sell the news?
With stocks this high, it’s little wonder that even strong earnings reports don’t move individual stocks much. Christopher Harvey, head of equity strategy at Wells Fargo, has noted that in the 24-hour period companies reported positive earnings beats, the average stock traded down 0.8%.
Ann Larson, senior analyst at Bernstein, noted that the S&P 500 had run up about 18% in the previous two and a half months, “perhaps discounting much of the good earnings results in advance.”
Low rates + strong earnings = stocks at new highs
Another factor pushing stocks to new highs: low interest rates.
“The U.S. has never begun an expansion with yields as low as today,” Jim Paulsen, chief investment strategist at The Leuthold Group, said in a recent note. “A combination of extremely low yields and strong EPS gains has historically proved to be a uniquely positive opportunity for stock investors.”
What could derail the earnings lollapalooza? Barring another out-of-left-field event like Gamestop, it’s still all about the stimulus (go big is going to succeed, it appears) and the vaccine: “Covid is still a huge X-factor,” Nick Raich told me. “Will there be mutuations and will the vaccines still be as effective as advertised? Barring that, stocks should continue to climb higher.”
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