Earnings to the Rescue
The stock market rally continues but it’s getting wobbly, amid fears of inflation and the COVID Delta variant. However, like the cavalry in the final reel, second-quarter earnings are riding to the rescue.
Q2 earnings season begins in earnest this week and sky-high estimates are prompting Wall Street to put aside its anxieties, at least for now.
On Monday, the three major U.S. stock market indices extended their gains from the previous week to touch new highs. The Dow Jones Industrial Average jumped 126.02 points (+0.36%), the S&P 500 rose 15.08 points (+0.35%), and the tech-heavy NASDAQ climbed 31.32 points (+0.21%). The small-cap Russell 2000 rose 1.82 points (+0.08%), maintaining its winning streak and confirming overall expectations for robust economic growth.
In pre-market futures trading Tuesday, stocks were essentially flat as investors awaited the initial batch of corporate operating results. First out of the gate will be the big banks, which are expected to post strong profits.
The emergence of the deadlier and more contagious COVID Delta variant spooked the markets last week but Wall Street is gaining confidence that it eventually will get reined in. We’ll see if that optimism about the Delta strain is warranted, but for now, investor attention has turned to corporate scorecards.
For the second quarter of 2021, the estimated earnings per share (EPS) growth rate for the S&P 500 is 64%, according to research firm FactSet. If 64% turns out to be the actual growth rate for the quarter, it will mark the highest year-over-year earnings growth rate reported by the index since Q4 2009 (109.1%).
Analysts have gotten progressively more optimistic about earnings. On March 31, the estimated year-over-year EPS growth rate for Q2 2021 was 52.1%. Nine sectors have higher earnings growth rates today (compared to March 31) because of upward revisions to EPS estimates.
For Q2 2021, 37 S&P 500 companies have issued negative EPS guidance and 66 have issued positive guidance. If 66 is the final number, it will represent the highest number since FactSet began tracking guidance in 2006
To be sure, the bull market has been long, and stocks are pricey. The forward 12-month price-to-earnings (P/E) ratio for the S&P 500 is 21.4. This P/E ratio is above the 5-year average (18.1) and above the 10-year average (16.2). However, stock prices are based on future projected earnings growth, so current valuations (as measured by the forward P/E) are not seriously out of whack. The rally appears to have more fuel left.
Expectations are high, but as the chart shows, the S&P 500 has a good track record of exceeding consensus hopes (see chart).
Over the past five years, actual earnings reported by S&P 500 companies have exceeded estimated earnings by 7.8% on average.
All 11 sectors are projected to report year-over-year earnings growth in Q2, led by the energy, industrials, consumer discretionary, financials, and materials sectors.
For the entire second half of 2021, the top three performing sectors were energy (45.1%), financials (25.5%), and real estate (23.3%). The three worst were consumer discretionary (11.4%), consumer staples (5.0%), and utilities (2.4%).
Risks are mounting, in the form of inflation and the COVID Delta variant, but Wall Street remains bullish (for now). Analysts in aggregate expect the S&P 500 to rack up a price increase of 11.2% over the next 12 months. Considering the horrors wreaked on humankind and the global economy by the coronavirus pandemic, the stock market has demonstrated remarkable resiliency.
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John Persinos is the editorial director of Investing Daily. He also writes the twice-weekly e-letter Marijuana Investing Daily. Send your questions or comments to firstname.lastname@example.org. To subscribe to his video channel, follow this link.