People pass a sign to JPMorgan Chase at its headquarters in Manhattan, New York City.
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Earning season is just around the corner, but traders will be far less interested in the fourth quarter results than they are in the first and second quarter forecasts.
The problem is, it’s not clear that CEOs are going to work together.
The banks are strong in the profit zone
Big banks like JPMorgan Chase kicked off the profit season on Friday with a good omen: The banks are going strong in the profit season.
“This is the first profitable season in recent history that banks have been leaders in the profitable season,” said Alec Young of Tactical Alpha.
In fact, the SPDR Bank ETF (KBE), a basket of big banks, is up 30% since the November election, far outperforming the S&P 500.
And unlike much of the market, bank stocks aren’t overpriced.
“They have a lot of room to move up, they’re not expensive,” said Young.
Why do we need guidance now?
“As the earnings season begins and gains momentum, a key factor in the fourth quarter earnings season will be not only how they met, missed, or exceeded expectations for the quarter, but also how reporting company management frames the quarters ahead “said Oppenheimer Asset Management John Stoltzfus said in a note to clients.
A strong earnings forecast for 2021 is crucial to confirm the foundation of the rally: this massive incentive combined with an effective vaccine will result in a dramatic expansion in corporate earnings from the first quarter, and especially in the second, third and fourth quarters.
“The S&P is NOT trading in Q4 numbers, but in … estimates for Q3 and Q4 2021,” DataTrek’s Nicholas Colas said in a recent statement.
S&P 500 earnings per share (ests.)
- Q4: USD 36.88
- Q1 2021: $ 37.59
- Q2 2021: $ 40.39
- Q3 2021: $ 44.22
- Q4 2021: $ 45.28
Overall, earnings are expected to rise 25% in 2021, and that’s just the current consensus. Many have considerably higher estimates.
The market is already partially reflecting these expectations. The S&P 500 rose nearly 50% from the March 23 low to November 2, the eve of the elections, largely driven by massive fiscal and monetary stimulus. A further 10% has risen since the elections, largely due to the assumption that there will be more momentum and further incentives to invest in clean energy.
“The market is expected to see a significant acceleration in earnings growth due to better than expected operational leverage,” Morgan Stanley’s Mike Wilson wrote in a recent release to clients.
Operating Leverage is an accounting term that measures how a company can increase profits by increasing sales.
Put simply, Wilson and other strategists anticipate that US corporations’ cost-cutting efforts in 2020 – cutting rents, cutting jobs, and cutting travel expenses – will dramatically improve bottom line results and accelerate corporate profits even further as revenues are expected to rise Year 2021.
More income plus lower expenses mean more profit.
Return to More Normal Revenues for Battered Sectors?
In particular, analysts expect mid-year earnings to accelerate significantly in sectors believed to be most sensitive to vaccine adoption, including airlines, banks and energy. UBS strategist Keith Parker noted that forward earnings for this particularly sensitive group were down about 36% from February 2020 to early January but are expected to rebound: “If people get vaccinated, they’ll likely be spending on it Areas affected by COVID “normalize” shortly thereafter, “Parker wrote in a note to customers.
The mid-third of vaccine-sensitive stocks also saw profits fall 9%. “So there is enough headroom for gains from stocks negatively impacted by COVID to normalize,” he wrote in a recent note.
The problem: It’s not clear that CEOs are ready to give the all-clear from the second quarter. Many – maybe most – will likely opt out.
“How can anyone in the travel or hospitality industry provide legitimate advice that is not just guesswork?” said Nick Raich of Earnings Scout. “Companies have been reluctant to provide guidance for some time. The worst forecast was the second quarter of last year. It is improving, but slowly.”
Are analysts still too pessimistic?
Another problem: will analysts dramatically underestimate earnings again in the fourth quarter, as in the third quarter? Analysts were caught flat-footed in the third quarter. Corporate earnings were far better than analysts expected due to incentives. The average company beat its earnings estimate by about 19%, well above the normally reported 3% increase.
Analysts again underestimate the strength of Corporate America in the fourth quarter?
Some, including UBS’s Parker, say it is, citing the dollar’s weakness (a big help for those making overseas profits), quarter-on-quarter GDP growth and a slow spike in the Fourth quarter earnings revisions.
Others note that the easing of stimulus in the fourth quarter coupled with weak employment growth suggests that the bottom line is likely to be far more modest.
The news so far has been encouraging. The few companies that reported earnings (most have quarters that end in November) have exceeded expectations by an average of 13%.
One problem: The market may already be calculating significant profit gains. Parker noted that previous announcements remained unchanged despite a significant increase on average.
Raich noted that it is not uncommon to raise prices when expectations are so high. “We are in the FOMO [fear of missing out] Phase in which people are still interested in entering the market without paying too much attention to income, “said Raich.
If we don’t get strong forecasts and upward revisions to earnings, this could change quickly.
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