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Welcome to RBC’s Markets in Motion, recorded July 26, 2021. I’m Lori Calvasina, Head of US Equity Strategy at RBC. Please listen to the end of this podcast for important disclaimers.
This week in the podcast, we review what we learned in the second full week of 2Q21 reporting season. Three big things you need to know:
- First, overall the tone from management teams improved in week 2 relative to week 1, with a focus on the strong demand and cash deployment backdrop, increased confidence on the 2nd half, and COVID concerns toned down.
- Second, while we generally sensed a better tone regarding the ability of companies to manage through margin pressures, we also came away with the impression that management teams are inclined to see general inflationary and supply chain pressures as enduring for a bit longer.
- Third, while upward earnings revisions are still happening, we continue to see a softening in earnings sentiment, driven by deterioration in Financials, Consumer Staples, Health Care, & Utilities specifically and Value, Defensives, & Cyclicals more broadly.
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Takeaway #1: Overall the tone from management teams improved in week 2 (last week) relative to week 1.
- The stock market climbed last week, but it is worth noting that the individual stock reactions stayed pretty mixed last week, with 41% of the 79 companies that reported rising 1% or more in the one day trading session that followed the release of their results, and 42% falling 1% or more in the same time frame. That’s similar to the trend in place for the entire reporting season so far.
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- We are also seeing, however, a clear divergence in performance between the companies that are beating consensus on EPS and revenues so far in 2Q21 reporting season, and those that are missing, with those that are beating moving higher and those that are missing moving lower.
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- At the same time, we are also seeing a shift towards higher quality taking hold that’s not entirely divorced from earnings. The companies that are beating on EPS and revenues are clearly skewed towards bigger market cap names.
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Looking beyond the stats and more closely at the commentary, some of the major positives we see in our transcript review are:
- Strong demand – the strong consumer and business demand remained key themes with 75% having a positive tone on 2021, we also thought a couple of the banks did a better job highlighting the case for loan growth last week than the week before,
- A better tone around guidance – we saw more of a willingness by some companies to express optimism on the 2nd half this past week, and companies raising guidance are being rewarded in terms of the share price reaction.
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- The strong cash deployment backdrop – this persisted even as the companies reporting have broadened out beyond Financials,
- COVID concerns were also toned down last week relative to the prior week.
- In week 1, COVID came across as more of a clear concern, while last week it came across as more as an issue to monitor, with several companies highlighting how challenges posed by the Delta variant could be managed and were unlikely to derail the recovery. This was true of the Airlines in particular.
Takeaway #2: While we generally sensed a better tone on margins, we also got the impression that most companies think inflation and supply chain pressures are unlikely to disappear anytime soon.
- On margins, more than twice as many companies are now in the expansion camp as the flat/contracting camp, and nearly half have discussed strong pricing power, but an increasing number are expecting inflation to persist as opposed to being transitory.
- On labor, there are admittedly some glimmers of hope as some have highlighted how they’ve been able to manage through with efficiency programs, retention programs, or compensation adjustments, and last week we continued to find a handful of companies highlighting how they expect labor pressures to abate.
- We haven’t found the same nuances in the inventory and supply chain discussions, which have become some of the biggest challenges discussed this earning season. Companies are generally citing lower than desired inventory levels, limited capacity to meet demand levels, and continued shortage through the end of the year.
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Takeaway #3: While upward earnings revisions are still happening to 2021 numbers, we continue to see a softening in earnings sentiment.
- On full year S&P 500 EPS, the bottom up consensus for 2021 has moved up to $195 from $193 over the past week, but 2022 has been flat at $214.
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- As a result the implied yr/yr change for 2022 has actually come down a little bit.
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- Additionally, the percent of revisions to the upside for the S&P 500 broadly has slipped to 74% in mid-July from 78% in June.
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- But this does look pretty lopsided, as it’s been driven by deterioration in Financials, Consumer Staples, Health Care, & Utilities specifically and Value, Defensives, & Cyclicals more broadly.
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- And the last point I’ll make on this issue is that nothing has happened so far in 2Q21 reporting season to suggest that 2Q won’t be the peak rate of change in S&P 500 EPS growth. Current estimates are tracking at 70% for 2Q, 25% for 3Q, and 18% for 4Q. It’s hard to see how any further upward revisions will take back half numbers above 70%.
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- The problem with that is historically the S&P 500 has been down 6 months after seeing an early cycle peak in the rate of change in EPS growth. To be sure, stocks are consistently higher 12, 24, and 36 months later suggesting that peak EPS growth is likely to be more of a short –term stumbling block for the stock market as opposed to something more nefarious. But it’s an event that does tend to cause some short-term indigestion in the stock market nonetheless.
That’s all for now. Thanks for listening. And be sure to reach out to your RBC representative with any questions.