Two “Data” items today:
#1: We often say that FactSet’s S&P 500 analysts’ earnings estimate graph is the “most important chart in the world” for US large cap equity investors. Estimates for 2021 earnings have gone from $167/share in January to $204/share today, an increase of 22 percent. The S&P 500 is up 23 percent year to date, closely matching those revisions.
As our annotations to this “most important chart” (see below) show, revisions to 2021 estimates have clustered around earnings reporting seasons. Analysts, and by extension investors, have been in “show me” mode all year. They have been unwilling to believe earnings could continue to improve in the face of both revenue and cost structure uncertainty. But, as Q3 reports are highlighting, US corporate earnings power remains not just robust but still on an upward trajectory.
You may, however, look at the top line on that chart (2022 estimates) and say, “wait a minute … estimates are NOT going up for next year … isn’t that a problem for the bullish case on US large caps?”
This next FactSet chart of sequential quarterly earnings expectations shows why that’s happening. The middle bar (first shaded) is Q3 2021, the quarter we’re seeing reported right now. As noted in our commentary at the top, Wall Street analysts’ earnings estimates were too low back in September ($49.30/share). With half (54 percent) the S&P 500 having reported, Q3 is looking more like $52.31/share, 6.1 percent better than expectations. Our thesis has been, and still is, that Q3 will come in slightly better than Q2’s $52.81. We’re well on the way to seeing that outcome.
Now, look at how little analysts have raised Q4 estimates (just 0.7 percent) or Q1/Q2 2022 (0.3 – 0.4 pct), even after seeing Q3’s upside surprises. It’s also worth noting that they expect the next 2 quarters to show LOWER earnings than Q3 2021. They get a touch braver in Q2 2022 and beyond, but even Q4 2022’s estimate of $57.94/share is only 9.7 percent better than Q2 2021’s actual $53.80.
Takeaway (1): Wall Street analysts, even after 4 straight quarters of seeing their companies handily beat earnings expectations, remain cautious on the near-term outlook for corporate profits. In essence, they believe we are at “peak earnings power” right now and any future operating leverage will have to wait until Q2 2022 at the earliest. No doubt supply chain problems, labor shortages, and inflation concerns are feeding into that pessimism.
Takeaway (2): to remain bullish here, one must believe the Street’s $221/share estimate for 2022 is low by at least 10 percent (i.e., actual will be $243/share). At a 21x multiple based on Friday’s close using $221/share, there’s no other reasonable conclusion even if you give the S&P credit for being +40 percent high-valuation Tech plus Amazon, Google, Tesla, and Facebook. At $243/share for 2022, the S&P would trade for 19x next year right now. Not cheap, but at least within bounds …
Takeaway (3): we can get to $243/share for 2022 just based on a $55/share Q4 2021 ($220/share annual earnings power) and 10 percent earnings growth next year. We’ll freely admit that this does require 1) margin expansion as S&P 500 companies leverage their pricing power to offset more than 100 percent of any cost inflation they experience and 2) continued US/global economic growth. Chair Powell may not like the first part, but that’s what markets are saying just now.
#2: With October in the books, here is the data for both last month and YTD returns across broad global equity market indices and US large cap sectors (all based on dollar denominated returns):
Global equities (October, YTD):
- S&P 500: +6.9 percent, +22.6 percent
- Russell 2000: +4.2 pct, +16.3 pct
- NASDAQ Composite: +7.3 pct, +20.3 pct
- MSCI All-World Equities: +5.4 percent, +16.1 percent
- MSCI All-World ex-US Equities: +3.0 pct, +7.6 pct
- MSCI EAFE (non-US developed economies): +3.2 percent, +10.3 percent
- MSCI Europe: +5.0 pct, +14.8 pct
- MSCI Emerging Markets: +1.1 pct, -1.5 pct
Comment: October’s global equity rally lifted all boats but US large caps led the way, as they have pretty much all year. MSCI Japan (down 2.6 pct in October) explains the difference between EAFE and Europe. MSCI Emerging Markets’ tough October was not due to China (MSCI China +2.5 pct), but rather South Korea (-1.5 pct) and Brazil (-8.7 pct). We continue to recommend US large caps (S&P 500) as our top geographic/market cap pick.
US Large Cap sectors (October, YTD), ranked by October price returns:
- Consumer Discretionary: +12.1 pct (note: Tesla +43.1 pct), +25.1 pct
- Energy: +10.3 pct, +51.6 pct
- Technology: +8.2 pct, +24.2 pct
- Real Estate: +7.6 pct, +30.8 pct
- Materials: +7.6 pct, +17.8 pct
- Financials: +7.3 pct, +36.6 pct
S&P 500: +6.9 percent, +22.6 percent
- Industrials: +6.8 pct, +18.0 pct
- Utilities: +4.7 pct, +6.7 pct
- Health Care: +5.1 pct, +18.0 pct
- Consumer Staples: +3.5 pct, +5.6 pct
- Communication Services: +0.2 pct, +19.0 pct
Comment (1): by our math, Tesla’s 43 percent gain in October was responsible for 0.9 points of S&P return, or 13 percent of the total. That’s not enough to explain the entire difference between the S&P 500 and other geographies like MSCI Europe or Emerging Markets last month, but still worth calling out.
Comment (2): October’s US large cap sector returns reflect investor confidence in further economic growth, with cyclical groups leading the way. We continue to favor Energy, Financials, Industrials and Health Care.
FactSet Earnings Insight report: https://www.factset.com/hubfs/Website/Resources%20Section/Research%20Desk/Earnings%20Insight/EarningsInsight_102921.pdf