The corporate earnings season for Q1 2021 is coming to a close and reporting thus far paints a rosy picture for firms. Top-line and bottom-line results have surprised strongly to the upside, and analysts have meaningfully revised up their end-of-year estimates. Moreover, with a large cash buffer on their balance sheets, firms are starting to put their capital to use. However, the tepid market reaction to the results suggests that investors had already priced in much of these strong results, defying more conservative analyst estimates. Thus, while the macro context remains supportive for equities, strong-if-not-extreme sentiment and stretched valuations pose significant headwinds to equity markets.
Saw It Coming
Firms are confirming the cyclical recovery seen in macro data
Over 80% of companies in the S&P 500 index and 65% of those in the Stoxx Europe 600 index have now reported their Q1 2021 results, which have been quite strong and broadly consistent with the economic recovery we have witnessed over the last few months. On a year-over-year basis, sales are up 11% and 3% for US and European firms, respectively. Over 70% of firms in the S&P 500 have beaten their sales estimates, well above the long-term beat rate of 60%, while over 65% of Stoxx 600 firms have beaten their sales estimates, well above their long-term beat rate of 58%.
Earnings thus far have been even stronger, with aggregate EPS growing by 57% and 41% year-over-year for S&P 500 and Stoxx 600 firms, respectively. These results have surprised analysts, with 86% and 74% of US and European firms beating their consensus estimates. The EPS beat rates this quarter are also well above the long-term average rates of 75% and 55% for S&P 500 and Stoxx 600 firms, respectively. Not surprisingly, estimates for the full year have been significantly revised upward over the last few weeks and are now 12% and 10% higher than they were at the beginning of the year for the S&P 500 and Stoxx 600, respectively.
Sector results reveal outperformance for pro-cyclical firms
Digging below the aggregate surface reveals some important takeaways from the reporting thus far:
- While nearly all sectors have surprised positively on their earnings (the exception being European Utilities), there is wide dispersion;
- Cyclical sectors – US Energy and Consumer Discretionary, European Materials and Industrials, as well as Financials from both indices – have generated the largest surprises in earnings growth, from 30% (Stoxx 600 Financials) to 158% (S&P 500 Energy);
- US technology firms – including those from both the Information Technology and Communication Services sectors – should not be underestimated, as they posted stellar numbers as well, growing earnings by 46% and 57%, respectively (representing surprises of 21% and 35% vs their respective estimates).
Capital deployment shaping up to be a tailwind
In addition to getting a backward-looking perspective on the health of the economy and business sector, earnings season also provides a useful forward-looking perspective, as firms discuss plans for capital deployment. While cash on balance sheets has fallen modestly (-4%) on a quarter-over-quarter basis for non-financial firms in the S&P 500 who have reported thus far, on a year-over-year basis, it is up 12% and represents a reservoir of demand commensurate with significant household savings rates. Thus far, most of this cash has been used for buybacks, which are up 17% on a quarter-over-quarter basis (though they remain 9% below their level a year ago). Dividends grew by a modest 2% on quarterly and annual bases, while capex shrank 13% over the last quarter and is now 2% below its level a year ago for these firms. Indeed, buybacks announced thus far this year are currently at USD 300bn, which is close to the USD 307bn of announced buybacks in all of 2020. In fact, announced buybacks are on pace with their 2019 trend (USD 702bn cumulatively) and even their 2018 trend (nearly USD 940bn cumulatively). If capital deployment continues to follow these patterns, it would represent a significant tailwind for equity markets (reduced supply) and, critically, for long-term inflation, as deteriorated capacity is not replaced.
A tepid response reveals high market expectations
In light of these encouraging results, the market reaction over recent weeks can be described as tepid at best. On average, S&P 500 firms have beaten their earnings estimates by 23% but have seen their shares fall by -0.2% the day after they announced their results. European firms have fared a bit better, with their average 32% surprise being rewarded by a 0.2% return the day after they reported. Looking at the asymmetry between beats and misses, i.e., the difference in price reaction for firms beating their earnings estimates versus those missing their estimates, we see that investors had a much more positive view than consensus estimates. In the US, the typical firm that missed its estimate saw its price decline nearly -1.7% more the following day than the price action for the typical firm that beat (relative to the market return on the same day). In Europe, the asymmetry stood at -0.5%.
Looking at sector performance reveals important divergences that indicate investors remain underexposed to a cyclical recovery. In the S&P 500, the Materials, Industrials, Consumer Discretionary and Financials sectors all saw a positive price reaction on the day after they posted their aggregate earnings surprise. On the other hand, Consumer Staples, Utilities, Healthcare, and Technology all saw a negative price reaction to their positive earnings surprise. The Stoxx 600 exhibits a similar pattern where Industrials, Financials, and Consumer Discretionary all saw positive price action in response to positive earnings surprises.
Overall, the earnings results are largely in line with our core scenario of a strong cyclical recovery that will push inflation higher and for which investors are not fully prepared. Such an environment is broadly supportive for equities, but with valuations at extreme levels on almost any measure – whether based on assets, earnings, or cash flows – equity markets are susceptible to disappointment on macro conditions or a turn in investor sentiment. Thus, while we retain a positive view on equities, it is biased toward those markets that we think will benefit most from a strong cyclical and inflationary recovery.
World Growth Nowcaster
World Inflation Nowcaster
Market Stress Nowcaster
- Last week, our World Growth Nowcaster continued its climb, mainly driven by data from both the US and EU.
- Our World Inflation Nowcaster stabilised at very elevated levels: inflation risk remains very high.
- Our Market Stress Nowcaster ticked up last week due to its liquidity component.
Sources: Unigestion. Bloomberg, as of 07 May 2021.
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