High Bar Set for US Earnings Quarter

Expectations for 2021 earnings and beyond are robust to say the least. History suggests such a high bar is harder to jump. As a reminder, the market prices in forward expectations and in order to do even better, results need to beat expectations. That will likely be a high hurdle looking forward.

The fundamentals driving market valuations are a combination of growth and inflation expectations with a swing factor of (emotional) animal spirits. The past 5 years has seen very different leading factors. In 2017, animal spirts were released by expectations of falling corporate tax rates and less regulation helping business profitability. As we can see from the chart below of forward earnings expectations, the S&P 500 had a very good year ending 2016 at 2238.83 and finishing 2017 at 2673.61 or 19.42% plus dividends. The boost to earnings we saw in 2018 was in a large part the benefit of a tax cuts, which we expect will be at least partially reversed to help pay for COVID debt and a greener future. That expectation was priced in well ahead of implementation making 2018 a challenge.

In 2019, earnings expectations started the year higher, as we often see, but by the end of the year there was actually no growth expected. In 2019, the S&P 500 was up 28.78% plus dividends. In between, when earnings moved significantly higher (tax cuts), the S&P 500 was actually down and was volatile. This is when the Fed was most aggressively removing accommodation (raising rates and reducing balance sheet). In 2018, the S&P 500 fell 6.24% less dividends, but had robust earnings growth.

Obviously the 2020 COVID pandemic was a shock to the world and earnings expectations are now back to growing with vaccine efficacy better than expected. At the start of 2021, expectations for the year were in the $163 area. Currently, expectations are for $191. Looking out over the next few years, the 2022 expectation is now $213 and the 2023 expectation is almost $236.

The risk going forwards with such high expectations and high market valuations are for events to develop that hurt earnings growth and reduce the very high multiple. This is what history reminds us that average returns going forward are lower when expectations are robust and are best when expectations are at their worst.

This we hear from FOMC Chair Powell and we expect nothing less than the dovish talk that he has become expert on given his 2018 policy FUBAR. We do expect Congress to ask about home affordability, which will likely be the question of the week. Low rates are driving up home prices and inflation pressures are pushing home ownership out of reach for many constituents.

Make sure you check out our weekly update in our PRO-EYES macro indicators each week to help figure out when it’s time to be cautious or when it’s time to be opportunistic. The recent readings suggest tactical risks in Q3 with extreme valuations, but central bank liquidity is still extremely supportive. We expect the FOMC could make a policy mistake if they are too aggressive in tapering.

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