#1: We’ve been telling you for months that Wall Street’s S&P 500 earnings estimates for Q2 and the rest of 2021 were too low and that current earnings power was $50/share. Even 6 weeks ago, the Street was looking for $44.59/share for Q2 and saying $50/share was off the table for the rest of the year.
As this FactSet chart of current Street S&P 500 quarterly estimates shows, our call was correct. Now that analysts have seen more than half the index report Q2 earnings, they have (finally) lifted their 2H 2021 earnings estimates to $50/share and Q2 is on track to post $51/share.
How did the S&P 500 outdo the Street’s estimates when Q2 GDP was weaker than expected? The simple, and sustainable, answer is earnings leverage. It’s always difficult to estimate what a company will earn coming out of a recession because businesses always adjust their cost structures down when demand dries up. When demand recovers, earnings pop but it is hard to predict by exactly how much. Since Q1 2021 posted $49/share, we knew analysts were being too cautious about the rest of 2021. Incremental revenues came though at higher than expected marginal profitability. It’s a story as old as the hills …
That chart also shows that analysts are STILL being overly cautious. Q2 should settle out at $51 – $52/share, and revenues will continue to grow in 2H 2021 and 2022 barring a large exogenous shock. The Street is looking for no earnings growth in 2H 2021, however, relative to 1H 2021.
This means estimates still have room to increase. That should keep the trend lines in what we like to call “the most important chart for US large cap stock prices” continuing to go up and to the right. Here is that chart, also courtesy of FactSet. The bottom line is 2021 S&P 500 earnings/share estimates, the top line 2022 estimates:
Takeaway: the market knows Street estimates are too low, and our best estimate is that the S&P 500 at 4,400 implies future earnings power of $220/share, or $55/share per quarter. That’s based on a 20x forward multiple, reasonable considering a 1.2 percent 10-year Treasury yield and the chance for cyclical upside going into 2022 – 2023. Can we get to a $60/share quarterly run rate in early 2022, the sort of upside investors will need to see to keep bidding up US stocks? Our answer is “Yes”, but we also know this is beginning to be a stretch goal rather than a base case. Still, as long as the US economy continues to recover at a reasonable pace, we’ll remain confident that US large caps have further upside.
#2: With July 2021’s global equity returns now in the books, here’s what worked, what didn’t, and why, in 4 points:
#1: July price returns by major geographic region, along with how each area is doing for the year-to-date. (Ordered from highest to lowest July returns)
- NASDAQ 100: +2.9 percent, +16.2 percent YTD
- S&P 500: +2.3 pct, +17.0 pct YTD
- MSCI EAFE: +0.8 pct, +9.0 YTD
- Russell 2000: -3.6, +12.7 pct YTD
- MSCI Emerging Markets: -6.4, -0.1 pct YTD
Comment (1): July was, in the broadest sense, a “more of the same” month with respect to global equity performance trends in 2021. US large caps led the field and widened their YTD performance gap. Emerging markets underperformed the most (more on that momentarily) but were already in last place after 1H 2021. Everything else fell somewhere in between these extremes.
We continue to favor US large caps over other global equity options. US small cap underperformance should not be as dire going forward, as we explained last week. We also continue to favor EAFE equities (specifically European stocks) over EM.
Comment (2): US Big Tech explains most of July’s difference between the S&P 500 and other global equity indices. Google rose by +10.4 pct last month, Apple by +6.5 pct, Microsoft by +5.2 pct, and Facebook by +2.5 pct. Only Amazon underperformed last month, down -3.3 pct. It’s worth noting that Apple and Amazon have underperformed YTD, +9.9 pct and +2.2 pct.
#2: Here are the major MSCI EAFE country constituents, also ordered by July’s price performance:
- MSCI Switzerland: +3.3 percent, +12.4 percent YTD
- MSCI France: +1.3 pct, +15.3 percent YTD
- MSCI United Kingdom: +0.3 pct, +12.0 pct YTD
- MSCI Germany: -0.2 pct, +8.7 pct YTD
- MSCI Japan: -0.6 pct, -0.7 pct YTD
Comment: MSCI Japan (23 pct of MSCI EAFE) has been a chronic underperformer this year relative to European equities. We continue to prefer MSCI Europe (+1.7 pct in July, +13.6 pct YTD) for non-US developed economy exposure. Japan’s negative population growth is too large a structural headwind, in our view. In terms of country exposure, we still like the UK over the rest of Europe.
#3: Emerging markets equities were a bit of a mess in July, and not just because of China’s local Big Tech crackdown:
- MSCI India: +1.0 percent, +11.1 percent YTD
- MSCI Taiwan: -0.6 pct, +19.8 pct YTD
- MSCI South Korea: -4.8 pct, +3.1 pct YTD
- MSCI Brazil: -7.8 pct, +0.9 pct YTD
- MSCI China: -13.6 pct, -12.0 pct YTD
Comment: at a 35 pct weighting in MSCI Emerging Markets, Chinese stocks will affect both returns and investor confidence in their overall EM exposure. We still prefer Taiwan or South Korea over a blanket EM exposure.
#4: Wrapping up with US large cap sector performance:
- Health Care: +4.9 percent, +16.5 percent YTD
- Real Estate: +4.6 pct, +26.9 pct YTD
- Utilities: +4.3 pct, +5.2 pct YTD
- Technology: +3.9 pct, +18.0 pct YTD
- Consumer Staples: +2.2 percent, +6.0 pct YTD
- Materials: +2.1 pct, +16.1 pct YTD
- Communications: +1.8 pct, +22.1 pct YTD
- Consumer Discretionary: +1.1 pct, +12.2 pct YTD
- Industrials: +0.9 pct, +16.7 pct YTD
- Financials: -0.5 pct, +23.9 pct YTD
- Energy: -8.3 pct, +30.2 pct YTD
Comment: the S&P 500 had 2 winning sectors noticeably helping July’s returns. Tech (28 pct of the index) did the heaviest lifting, pushing the index 1.0 percentage point higher. Health Care was actually the best performing sector, but its 13 pct weight in the index meant its contribution was 0.7 points. Our recommended cyclical overweights remain Energy, Financials and Industrials (in that order). We still believe Utilities and Consumer Staples are underweights, with proceeds to go towards cyclical exposure and Technology.