Client Center

Investment Strategy
by Larry Adam
Chief Investment Officer, Private Client Group

Weekly Headings

April 9, 2021

Key Takeaways

  • Belief that the current rate of earnings beats can continue
  • Reopening sectors have rallied but earnings lag
  • Forward guidance may offer insights on inflation & capex

This Tuesday was National Scrabble Day! The timeless board game that is sold in more than 120 countries in nearly 30 languages revolves around forming words from a pre-determined pool of lettered tiles. As the game relates to our equity market outlook, the only word on our mind this week is earnings, since we have touted that earnings, rather than multiple expansion, would be critical in helping the S&P 500 score points this year. We’re hopeful the 1Q21 earnings season will be the first step toward achieving our 2021 earnings estimate of $190, which is not only above the consensus estimate of $175, but  would also translate to the best year of earnings growth since 2010. At a minimum, strong earnings will be needed to support the second best start to a year (S&P 500: +11.5% YTD) since 1998. However, a more optimistic tone around earnings may serve as a bonus and upside to our base case, therefore we’ll spell out our expectations and dynamics to watch throughout earnings season.

  • Beats Have Been Beyond Words | Expectations are elevated for the 1Q21 earnings season as the S&P 500’s 26.6% earnings growth estimate is expected to make this the best quarter of earnings growth since 3Q18; however, if the trend over the last 20 quarters for an aggregate EPS ‘beat’ of 6.8% continues, it would be the best quarter since 3Q10. Given the underlying strength of the US economy, which has rebounded more quickly than expected due to factors such as improvements on the vaccine front, we believe it is a feasible feat, and necessary to reach our earnings estimate, which is ~9% higher than consensus.
  • Putting In A Good Word For Tech-Oriented Sectors | In aggregate, we expect S&P 500 earnings to reach pre-COVID levels in the third quarter of this year on a trailing four-quarter basis. However, there has been significant dispersion in the earnings recovery at the sector level. While many of the ‘reopening’ sectors have outperformed as of late, the earnings of these sectors continue to lag. For example, the trailing four-quarter earnings per share for both the Energy and Industrials sectors are expected to remain 112% and 56% below pre-COVID levels, respectively, and are not expected to recover their earnings until 2022 at the earliest. Meanwhile, we’ve stood by some of our preferred sectors that outperformed during the worst of the pandemic on the basis of more resilient earnings. Specifically, the Information Technology and Communication Services sectors have already returned to pre-COVID earnings levels, and by the end of this year, their earnings should be 27% and 13% above these levels on a trailing four-quarter basis, respectively. In addition, these two sectors have posted among the top three highest aggregate earnings beats over the last 20 quarters, with Tech and Comm Services beating EPS estimates by 7.7% and 7.9%, respectively.
  • Financials First On The Board | Coming into the quarter, the Financials sector was expected to see the strongest earnings growth of any sector (+80.3%). With a number of the ‘Big Banks’ kicking off the 1Q21 earnings season results this week, bottom line EPS results have exceeded estimates by a staggering 43%. While some of the EPS beat is attributable to substantial COVID-related reserves being released, operations such as trading activity and investment banking were robust. As strong Financials results benefit aggregate S&P 500 earnings, 1Q21 index earnings were revised $1.50 (4%) higher following the reported results.
  • Actions Will Speak Louder Than Words For Small Cap | Small-cap equities have outperformed large-cap equities by over 38% since the March lows last year, but that was on the prospect of superior earnings growth, with the Russell 2000 expected to grow its earnings by over 500% in Q1 and 140% in 2021. However, within the small cap space, selectivity remains critical. In 2020, 48% of Russell 2000 companies had negative earnings, and this number is expected to remain elevated at 38%, 32% and 26% in 1Q21 and full-year 2021 and 2022, respectively. These figures are vastly higher than the S&P 500, which had 17% of its companies post negative earnings in 2020, with projections of only 5.1%, 3.4% and 0.2% for 1Q21 and full-year 2021 and 2022, respectively.
  • Get The Word On Margins, Capex, & Supply Chains | This earnings season should be the complete opposite of Q1 last year in regards to management guidance and commentary. Last year, due to the pandemic-induced uncertainty, a majority of S&P 500 companies were unable to provide guidance. This earnings season, with the US economy gaining momentum and nearing a return to normality, guidance will not only be expected, but will provide us with more color as we calibrate our optimistic earnings outlook. In addition to revenue guidance, commentary regarding potential pricing pressures and plans for excess capital will be in focus. Some industries are still plagued by lingering supply chain disruptions which may increase their input prices while other firms have surpluses related to combating the pandemic. The manner in which these bottlenecks and inventories are addressed may provide some timely insights regarding the trajectory of inflation and net margins, which are expected to trend back above their five year averages. In addition, with record cash on balance sheets, we expect firms to outline increasing plans for capex (e.g., investment in new technologies) or shareholder friendly actions (e.g., dividends and buybacks).

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All expressions of opinion reflect the judgment of Raymond James & Associates, Inc., and are subject to change. Information has been obtained from sources considered reliable, but we do not guarantee that the material presented is accurate or that it provides a complete description of the securities, markets or developments mentioned. There is no assurance any of the trends mentioned will continue or that any of the forecasts mentioned will occur. Economic and market conditions are subject to change. Investing involves risk including the possible loss of capital. International investing involves additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets. Companies engaged in business related to a specific sector are subject to fierce competition and their products and services may be subject to rapid obsolescence. Past performance may not be indicative of future results.