The pandemic is over according to corporate earnings in the US. Or at least that’s a crude way to conceptualize of fourth quarter results.
Headed into reporting season, consensus expected S&P 500 profits to fall 11% YoY. But, with 367 firms representing 84% of index market cap on the books, earnings actually rose 2% from Q4 2019.
“Profits have already surpassed their pre-pandemic level,” Goldman’s David Kostin wrote Friday evening, adding that the results “easily” beat analyst forecasts and registered “a new record high.”
Around two thirds of the S&P beat by at least one standard deviation. With the sole exception of Q3 2020, that’s the best performance versus consensus in nearly a quarter century.
Those beats didn’t translate into above-average returns, though. As Goldman went on to note, “the median stock beating estimates lagged the index by 85bp on the subsequent day.” That’s an extension of a pandemic trend, and is the worst post-report performance in history.
What accounts for that? It’s the same dynamic that makes virtually every economic data point besides weekly claims a non-event. If it’s not current (almost literally) then it doesn’t matter. Or at least not to market participants. “The expected recovery has made backward-looking metrics less relevant for the forward-looking market,” Kostin remarked.
It’s not earnings folks are after these days, it’s guidance. And some management teams are still loath to provide any. Those that have, and especially those brave enough to guide 5% or more above consensus, outperformed by a median of 115bp on Goldman’s data.
Consensus estimates for 2021 S&P EPS have risen $5 over the course of reporting season. Goldman has now raised their full-year, top-down estimate to $181 from $178, to account for what Kostin expects to be “higher sales and profit margins that overcome input cost pressures thanks to high operating leverage and the growing index weight of high-margin Tech firms.” Goldman’s new EPS forecast for the index is $7 above consensus.
With the S&P already some 16% higher than this time last year, where’s the upside going to come from? After all, even Goldman’s slightly higher EPS estimate for 2021 ($181) implies a 22X multiple.
Well, fiscal stimulus is the most obvious candidate when it comes to driving additional gains. Goldman’s baseline expectation is for $1.5 trillion in additional virus relief. The bank sees Q2 growth of 11% (annualized) in the US.
“From a flows perspective, additional stimulus payments should continue to support household demand for US stocks,” Kostin said, adding that the bank’s retail favorites basket “continues to rally.” It’s up 21% in 2021, if you’re keeping track at home, which, if you’re buying those stocks, you probably are, by definition.
As far as whether higher rates and inflation will eventually dent equities, Goldman isn’t overly concerned. The story is familiar. “Both theory and history suggest that the equity market can rise alongside higher interest rates as long as the rise in rates is orderly and driven by growth,” the bank said.
So, as long as yields don’t rise too far, too fast, and as long as the composition of rate rise is the “right” mix, things should be fine.
Recent color from PMIs has evidenced sharp increases in input costs. Some (perhaps quite a bit) of that should abate once supply chain frictions ease as economies re-open and herd immunity gets closer, but there’s obviously some concern about the extent to which passing along rising costs is difficult when so many consumers are unemployed.
Again, Goldman isn’t all that worried. “S&P 500 operating leverage is at the highest level in years, helping margins grow alongside revenues [and] high SG&A expenses indicate room for firms to cut costs,” Kostin went on to say. As far as commodities, it’s worth remembering that some industries are helped by higher commodity prices and the ones that aren’t typically hedge.
As far as rising labor costs go, the “good” news is, labor has no real power. We all know that. And it’s not going to change anytime soon.
Besides, as Kostin points out, “company filings suggest that labor costs account for just 13% of S&P 500 revenues, meaning a 100bp acceleration in wage growth would reduce EPS by about 1%.”
Dear labor: “If you have the means, I highly recommend picking up” some stocks. They “are so choice.” (That’s a Ferris Bueller joke.)
““S&P 500 operating leverage is at the highest level in years, helping margins grow alongside revenues [and] high SG&A expenses indicate room for firms to cut costs,”
That’s fascinating and although current trends are good, the higher the level of operating risk, the greater the risk if throughput (revenue) falls. I find it interesting that labor costs are only 13% of S & P revenues as so much of our economy is comprised of service businesses which are labor intensive and most of the labor costs at manufacturing businesses are actually expenditures for services — accounting, HR, engineering, materials management, etc. Also, with as much outsourcing as our firms do, the fact that OL is so high is a bit of a surprise. That ratio rises in conjunction with fixed costs but outsourcing effectively converts fixed costs into variable costs and lowers OL. I would love to know more about these trends because there seem to be some contradictions in the data. The latter part of the quote is logical since most firms find it far easier to cut costs than to raise revenue.
Thanks for including this info here. Most people don’t seem to really understand operating leverage and its systemic impact on profits. Boeing and the airlines will explain. So can our utilities.