Traders work on the floor of the New York Stock Exchange.
Profits from the explosion are forcing analysts to increase their estimates for 2021.
With just over half of the companies reporting, the profits turn out to be a pleasant surprise for the trading community.
The GameStop / Robinhood fiasco turns out to be a minor blow to the markets in the first weeks of 2021. The main theme that ended 2020 – belief in a vaccine’s effectiveness – remains intact.
“Markets are moving to new highs as cases of Covid decline, stimulus measures hit the upper bound of expectations and we continue to see very positive earnings surprises,” said Nick Raich of Earnings Scout.
Surprises and increased earnings
Stocks are expensive. The S&P 500 is trading at a historically high level of 22 times 2021 earnings. For stocks to continue to advance, two things had to happen: some very big gains for the fourth quarter and a business forecast clear enough that earnings estimates for Q1, 2 and 3 continue to rise.
These two conditions are met. First, profits exceed estimates by more than 17%, about five times the normal average and at the same level as in the third quarter. The reason: Analysts underestimated the strength of the economic recovery.
Q4 profit: mid-term (53% of results)
- Beat: 83%
- Percent above estimate: 17.3%
- EPS growth: up 1.6%
Second, earnings surprises now translate into higher estimates for the first and second quarters.
S&P 500 earnings estimates for the first quarter of 2020
- January 1: up 16%
- Today: up 20.5%
S&P 500 earnings estimates for the second quarter of 2020
- January 1: up 45.7%
- Today: up 49.9%
Analysts are generally overly optimistic and start lowering their estimates as the quarter progresses, but in the second quarter the opposite happened.
“This is an unusual event; the street is generally cutting numbers at this point in the current quarter,” DataTrek’s Nicholas Colas said in a recent memo.
Technology, materials and real estate income were particularly strong.
Sell the news?
With stocks this high, it’s no wonder that even strong earnings reports don’t move individual stocks much. Christopher Harvey, head of equity strategy at Wells Fargo, noted that in the 24-hour period companies reported positive gains, the average stock traded down 0.8%.
Ann Larson, senior analyst at Bernstein, noted that the S&P 500 had climbed about 18% in the previous 2.5 months, “perhaps ruling out a lot of the good results ahead.”
Low rates + strong earnings = stocks at new highs
Another factor pushing stocks to new highs is low interest rates.
“The United States has never started an expansion with returns as low as it is today,” said chief investment strategist Jim Paulsen of The Leuthold Group in a recent memo. “A combination of extremely low yields and strong EPS gains has historically proven to be a particularly positive opportunity for equity investors.”
What could derail lollapalooza’s earnings? Barring another left off-field event like GameStop, it’s still all about the stimulus (go big will succeed, it seems) and the vaccine: “Covid is still a huge X factor,” Raich said. “Will there be mutations and will the vaccines still be as effective as advertised? Otherwise, stocks should continue to climb.”
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