Welcome to RBC’s Markets in Motion podcast, recorded April 30th, 2021. I’m Lori Calvasina, Head of US Equity Strategy at RBC Capital Markets. Please listen to the end of this podcast for important disclaimers.
This week in the podcast, we discuss where we are in the earnings cycle, and what it means for stock prices going forward. The big thing you need to know: while 2021 S&P 500 EPS is tracking better than expected, we think expectations for decelerating EPS growth in the back half of 2021 are a problem for the stock market, and help make the case for a short-term pullback, or volatility, in the US equity market in the months ahead.
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Now, the details.
Key point #1, results have been great so far in 1Q reporting season, but that hasn’t been driving stock market performance which has been pretty flat since mid April.
- US equity investors are knee deep in 1Q21 reporting season, which is currently in the middle of its busiest two weeks.
- But we’ve found that the investors in our meetings over the past couple of weeks have been less preoccupied with the strong beat rates that have been seen so far, which, to be fair have been seen for a few quarters already, and have been more concerned with what lies ahead.
- On this topic, we’ve been spending a lot of time highlighting to investors how the rate of upward EPS estimate revisions in the S&P 500 has started to slow, falling from 71% in December to 67% in late April. This kind of deceleration usually dampens 12 month forward stock market returns as it tends to signal that the best part of the earnings story is already behind us and that earnings sentiment is starting to wane.
- One issue in particular that investors have been very focused on is margins, where the S&P 500 is currently being pulled and pushed by a number of powerful tailwinds and headwinds.
- Strong operating leverage coming out of the pandemic, declines in COVID related costs, the powerful move higher in the rate of change of GDP, and pricing power are all positives for margins at the moment, while supply chains, higher input prices, rising wages, and the Dollar are all current or looming headwinds.
Key point #2, we think one of the biggest problems for the stock market at the moment on the earnings front is that the rate of change in EPS growth appears to be peaking right now in calendar 2Q.
- As of late April, expected S&P 500 EPS growth was tracking at 53%, based on the bottom-up sell-side consensus for individual companies, with rates of change much lower than that expected in the 2nd half – 20% in 3Q and 15% in 2Q.
- This trajectory is a problem for the stock market because over the past three cycles, stocks fell modestly in the 6 month period that followed an early cycle peak in the rate of change of S&P 500 EPS growth.
- While this isn’t a great data point for the bulls, it’s also not a great one for the bears, as stocks still tend to be higher 12 months after such a peak occurs.
- As a result, we see peaking earnings growth as supporting the case for a short-term pullback in the broader market in the back half of 2021, or heightened volatility, but not a derailment of the young bull market.
Key point #3: peaking earnings growth is just one of several things that make the case for a short-term pullback, or heightened volatility, in stocks in the months ahead.
- We continue to see extremely euphoric readings on our positioning indicators.
- On the institutional side, US equity futures positioning among asset managers, as tracked by CFTC, has returned to levels close to post pandemic peaks, which are well above most pre-pandemic peaks, recently.
- On the individual investor side, net bullishness on the AAII survey recently returned to +30%, which has historically been a trouble spot for the market.
- Equity stakes in US households have also returned to Tech bubble highs, pointing to stretched positioning there.
- And finally, bottom up valuations are also back to Tech bubble highs.
- Let us not forget that a pullback is typical mid way through recession recoveries.
- Investors shouldn’t panic if we get a pullback, but do need to be mentally prepared for the possibility.
That’s all for now. Thanks for listening. And be sure to reach out to your RBC representative with any questions.