Two “Data” topics today:
#1: How good does Q3 US corporate earnings season have to be to get a large cap stock rally into the end of 2021? In a typical quarter, companies beat Wall Street’s earnings estimates by 3-4 percent. In Q1 and Q2 2021, however, the beats were much higher: 23 and 17 percentage points above analysts’ estimates, respectively. It is that extraordinary level of operational outperformance that has given us a 17 percent YTD return on the S&P 500.
Our answer: the companies of the S&P 500 need to beat by an aggregate 10 percentage points this quarter, or we’ve almost certainly seen the highs on US equity markets for the year. The graph below shows our rationale:
The S&P 500 reported $53/share ($52.80, to be precise) in Q2 2021. If that was the peak for post-pandemic earnings, then US large caps are clearly overvalued at 21x earnings (4,400 S&P divided by $53 x 4). Who pays +20x for declining earnings power? No one.
The only way 21x forward earnings makes sense is if markets are expecting Q3 to show HIGHER earnings than Q2. How much higher? It doesn’t have to be a lot; our baseline estimate is $54/share – just enough to show that US corporate earnings power is still climbing and Q4 2021 and 2022 estimates are too low.
Takeaway: we think it is reasonable to expect the companies of the S&P 500 to beat Q3 expectations by at least 10 percentage points because Wall Street never fully reset their estimates for the quarter, even after seeing companies beat by 23 and 17 percentage points in Q1/Q2. Yes, we’ve been talking a lot about this issue in recent weeks, but its importance merits all the attention we can give it. We always hesitate to say that a given earnings season is the “most important ever”, but Q3 2021 comes very, very close to justifying that sort of hyperbole.
#2: If you torture the data from Friday’s September US Jobs Report long enough you can get it to say anything you want. Job growth missed expectations …. Bad! The unemployment rate broke below 5 percent… Good! There was something for everyone.
In our view, however, only the market’s opinion matters and on that count the report was “good enough”:
- Good enough to send 10-year yields to 1.61 percent, the highest levels since early June 2021.
- Good enough to see Fed Funds Futures discount higher odds of 2 rate hikes in 2022.
- Good enough to push the CBOE VIX Index to 18.8, among the lowest closes in the last month, even if the S&P 500 was down modestly on Friday.
- Good enough, in other words, to convince markets the US economy remains broadly on a slow-growth recovery track out of the Pandemic Recession.
Digging through the internals of the report, it’s easy enough to see how markets came to this conclusion:
First, unemployment among both college-educated workers and those who finished their formal education with a high school diploma declined to new post-pandemic lows. College grad unemployment is now 2.5 percent, a full point lower than at the end of Q2 2021. High school grad unemployment was 5.8 percent in September, down 1.2 points from 7.0 percent in June. The chart here covers the period from January 2020 to September 2021:
Second, US labor force participation (LFP) among workers aged 25 – 54 hit a post-pandemic high of 81.7 percent. As the chart below shows, total LFP is stuck in the doldrums due mostly (we believe) to retirements. Working-aged Americans are, however, re-engaging with the US labor market.
Lastly, both hourly and weekly wage growth was 4.6 percent year-on-year in September, right in the middle of the channel where this data has been trending. Our view on wage growth is that giving workers a boost to their incomes propels short-term economic growth with little risk in creating long-run inflation. As we covered last week, history very clearly says you need years of wage growth before you get a lasting upward price spiral.
Final point, tangentially related to US labor markets, but important: Friday’s Jobs Report did not move the Atlanta Fed’s GDPNow model, which was looking for 1.3 percent Q3 growth before the data came out and was still at 1.3 percent after its release. That tells us the Jobs Report is consistent with a slow-growth US economy, rather than a one-month anomaly.
Takeaway: that September’s Jobs Report reflects a Q3 exit rate of just 1-2 percent GDP growth is yet another reason the upcoming earnings season is so important to the direction of US/global equity prices. The tempo of the US economy has clearly slowed from the first half of the year, when GDP growth was 6-7 percent. That means investors cannot rely on +5 pct GDP growth to deliver earnings surprises. Those now need to come from corporate earnings leverage alone.
Atlanta Fed GDPNow model: https://www.atlantafed.org/-/media/documents/cqer/researchcq/gdpnow/RealGDPTrackingSlides.pdf