With US corporate earnings season kicking off this week, we’ll dedicate today’s Data section to this topic. Under ordinary circumstances, quarterly reporting cycles don’t typically have much of an influence on aggregate investor psychology. We’re not willing to be so blasé about this one, though. Valuations are high because markets believe earnings will show a rocket-like trajectory later this year. Q1 2021 results are the launch pad, however, and it needs to be rock solid for investors to hold on to those outsized expectations for later in 2021 and into 2022.
Three points to cover, using data from FactSet’s latest Earnings Insight Report (link below):
#1: The Street is looking for 24.5 percent S&P 500 earnings growth in Q1 2021 versus Q1 2020, but the market likely has its eyes set on something closer to 30-35 percent growth. Here’s why:
- Wall Street analysts have consistently guessed way too low in terms of corporate earnings since their trough in Q2 2020. For example, in that quarter their models showed a 44 percent year-over-year decline, but the actual result was a 32 percent drop.
- That 12-point Q2 2020 outperformance was not a one quarter phenomenon. In Q3 companies reported 15 points better earnings comps than expected (-6 pct vs. -21 pct) and in Q4 the gap was 13 points (+4 pct vs. -9 pct).
- The average quarterly beat since the pandemic lows has been 13 points.
Takeaway (1): even if you haircut that historical pandemic beat amount, assuming that analysts are finally catching on, it’s reasonable to think the market expects 5-10 incremental percentage points of earnings growth for Q1 2021 in excess of Street expectations. Given the relatively quick pace of US economic recovery – faster than analysts have likely factored in – that seems entirely reasonable.
Takeaway (2): would the S&P 500 break out to new highs if Q1 wasn’t going to be a blowout quarter? We doubt it.
#2: There will be a very large gap in Q1 2021 sector earnings performance, and that lines up with the cyclical/growth stock divide.
- As mentioned, the Street is looking for 25 percent Q1 year-over-year earnings growth.
- Analysts’ estimates for Materials and Financials, 2 key cyclical groups, are currently showing expected Q1 comps of 46 and 79 percent respectively.
- Expectations for Consumer Discretionary earnings, which includes Amazon, are for 103 percent growth over Q1 2020. Analysts’ estimate for AMZN sits at 89 percent expected growth, so ex that “lockdown-play” the group should still print very strong reopening-driven earnings growth.
- Classic growth groups like Technology, Health Care and Communication Services are expected to show 22, 20 and 14 percent earnings growth. That’s below the S&P as a whole, but still quite strong. Worth noting: Comm Services earnings growth will mostly come from Google and Facebook, where analysts are looking for 38 and 60 percent growth from last year.
- Bringing up the rear are defensive groups like Utilities, Real Estate and Consumer Staples at just 3, 2 and zero percent year-over-year growth.
- Finally, we have Energy and Industrials. These 2 groups are expected to still post negative earnings comparisons to last year, down 15 and 17 percent.
Takeaway (1): no one sector, let alone one company, is representative of that 25 percent Q1 2021 S&P 500 earnings growth. You’ll see flashy, attention getting comps in cyclicals. You’ll see growth company prints and wonder why they aren’t as good as the average US corporate earnings growth rate. We know you know not to compare earnings reports across sectors, but the point here is that Q1 2021 will be exceptionally “noncomparable” across industry groups.
#3: We’ll close out with the “one chart that matters most” when it comes to tracking US corporate earnings: FactSet’s aggregation of Wall Street’s 2021 (bottom line) and 2022 (top line) S&P earnings estimates. As we’ve been calling out recently, these stalled out 3 weeks ago but are now increasing once again.
By our math, the “right” numbers here are $195/share for 2021 (not the $176.76 shown) and $223/share for 2022 (not $202.83). Why? First, because we know the Street is/should be 10 percent low on its Q1 numbers (Point #1 above) and so at least the same error rate should logically apply to 2021/2022 estimates. Second, with the S&P 500 at 4,128 and a reasonable forward earnings multiple of 18.5x that implies the market expects $223/share for next year. Ballpark numbers here, yes, but directionally correct in our view.
Pulling this all together: this needs to be one very, very strong earnings season to justify current prices and give investors confidence the best (or least “better still”) is yet to come. We’ve flogged the importance of earnings leverage off a cyclical bottom to death in these notes. We are confident it will appear but Point #2 is a good reminder that it will be unevenly distributed and, on some days, and in some sectors, it will be hard to find. In the end, all that matters is we get that 10 percent aggregate upside S&P earnings revision and managements express confidence in further operating leverage as the US economy continues to heal.
FactSet Earnings Insight report: https://www.factset.com/hubfs/Website/Resources%20Section/Research%20Desk/Earnings%20Insight/EarningsInsight_040921.pdf