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Charting the Market: Previewing a Pivotal Q1 Earnings Season

  • Expectations are high for the first earnings season on the road to recovery; can firms deliver?
  • Global equities have rallied for 5 consecutive months. Will this earnings season stall the rally or help extend it?
     
Head of SPDR Americas Research

The 2021 first quarter earnings season will provide an updated glimpse into how firms around the world are navigating the recovery and the reopening of economies. After all, this will be the first quarter of earnings data covering a time period simultaneously featuring more broad-based vaccine distributions and the relaxation of certain capacity restrictions.

The results are also occurring at a time where global equities have rallied for five consecutive months, and broad-based valuations are seemingly stretched relative to historical levels (97th percentile).1 And while the broad market has rallied, certain segments at the sector level have rallied more than others based on their relationships to the macro factors propelling this rally (e.g., cyclicals and rates).

Combine these factors together and it is a pivotal earnings season. If growth disappoints, the rally may stall. If growth follows the latest sentiment, then the rally could be extended. In this month’s Charting the Market, global earnings trends will be analyzed ahead of results being released, providing insights into what to expect for the first earnings season on the road to recovery.

Sentiment is positive with upgrades made globally
In the US, over the last few months, analysts have upgraded first quarter earnings-per-share (EPS) growth expectations for S&P 500® firms by the largest margin ever, boosting estimates by 6%. This is in stark contrast to the historical analyst revision trends in the preceding months to the first quarter earnings season, as expectations have historically declined as shown below.
 

Source: FactSet as of April 1, 2021. Characteristics are as of the date indicated, are subject to change, and should not be relied upon as current thereafter. EPS growth estimates are based on Consensus Analyst Estimates compiled by FactSet.

The same trend is occurring on a full-calendar-year basis as well, as the current year 2021 estimates have increased by 5% during the last three months — much greater than the historical average decline over the last five (-2.5%) and ten (-2.0%) years for EPS estimates during the first quarter of a year.2 This level of positivity, however, is not confined to just the US or US large caps. As shown below, the trailing 3-month upside-to-downside revision ratio across all regions for full year 2021 results is well above a ratio of one (indicating more upside revisions relative to downside by analysts).

Source: FactSet as of April 1, 2021. Characteristics are as of the date indicated, are subject to change, and should not be relied upon as current thereafter. EPS growth estimates are based on Consensus Analyst Estimates compiled by FactSet.

The trend above is the inverse of what occurred at the start of the pandemic, when the sizeable uncertainty of COVID-19 led to noticeable downside revisions. As a result, with the economy improving, evidenced by similar upwardly revised global economic growth forecasts by the IMF,3 analysts are continuing to course-correct their views.

This optimism, combined with the low base effects (negative growth in 2020), rising commodity prices positively impacting the previously beleaguered Energy and Materials markets, have global equities poised to post their strongest calendar year earnings growth since 2010 (+28%) – led by a 66% year-over-year growth rate for the first quarter.4

For the US in particular, the Q1 growth rate of 24% will be the highest since the tax-cut-fueled rate of 26.1% in 2018. And the Q1 24% rate could end up being higher after all the results are in, considering:

  • S&P 500 firms in the prior two quarters also witnessed a hike in expectations before results were reported;5
  • In each of those two quarters, firms beat expectations at record rates of 84% and 78%, respectively, in Q3 and Q4 of 2020.6

Cyclicals lead on sentiment
Powering earnings revisions have been the more cyclical segments of the market (e.g., value), matching the performance trends witnessed recently as well. As shown below, 2021 revisions for different versions of S&P 500 value styles have been stronger than the broader market and growth-oriented firms over the past three months, illustrated by pure value firms having 2021 earnings revised upwards by 13% compared to just 9% for pure growth. And while the Q1 EPS growth figures for value are below that of growth, the full year growth figures are stronger — a representation of the positive forward-looking outlook analysts have for the more cyclical and expansionary parts of our economy. Considering price multiples to access this EPS growth are lower for value than growth styles,7 value investing potentially offers a cheaper source of elevated growth in this market today, as also discussed in our latest article on positioning amid a reflationary rate regime shift.

Source: FactSet, as of April 1, 2021. Characteristics are as of the date indicated, are subject to change, and should not be relied upon as current thereafter. EPS growth estimates are based on Consensus Analyst Estimates compiled by FactSet.

The trend of upbeat revisions for cyclicals is more clearly apparent at the sector level, illustrated by trailing 3-month upside-to-downside ratios. As shown below, Energy, Materials, and Financials lead all sectors in terms of change to full-year earnings. Additionally, Energy, Financials, and Industrials have the strongest revision ratios. Not only do these cyclical segments have positive earnings sentiment, but price momentum is also supportive, considering that Financials, Energy, and Materials all rank in the top three of sector momentum as shown in our chart pack. Given that macro dynamics are also supportive for these markets (higher rates, inflation, and commodity prices) and valuations are constructive, these three sectors are areas to watch during this earnings season.

Source: FactSet, as of April 1, 2021. Characteristics are as of the date indicated, are subject to change, and should not be relied upon as current thereafter. EPS growth estimates are based on Consensus Analyst Estimates compiled by FactSet.

Growth from thematics
Cyclical value stocks are not the only segment with expected above-market growth. While traditional growth stocks, as shown above, are not expected to grow earnings above the broader market, firms at the forefront of the innovations re-shaping our society are. Fueled by a 43% year-over-year growth rate for Q1, as shown below, their expected 27% growth rate in 2021 is above that of the market and traditional growth stocks. The higher levels of growth reported above have also been upgraded over the last few weeks, in excess of what broad equities have been. Since the end of December, EPS growth for innovative firms for Q1 and 2021 have been increased by 9.5 and 6.8 percentage points, compared to the S&P 500’s 7.3 and 6.3 points, respectively.

Source: State Street Global Advisors, FactSet, as of April 1, 2021 based on the holdings of the S&P Kensho New Economies Index. *Growth is measured by the growth of the median company in the subsector. Characteristics are as of the date indicated, are subject to change, and should not be relied upon as current thereafter. EPS growth estimates are based on Consensus Analyst Estimates compiled by FactSet. 

This level of positivity reflects the change our society is undergoing, and the potential future growth opportunities from firms on the leading edge of this change. Yet, while headline growth figures are expected to be above the market, not all segments innovate at the same pace. That has translated into higher growth expectations for different areas.

Virtual reality and nanotechnology stocks, as shown below, are expected to grow earnings by over 60% year-over-year in the first quarter. For full-year 2021, electric vehicles, clean technology, and autonomous vehicles are expected to grow earnings at the fastest rates, reflecting the potential in clean energy and smart transportation firms – two areas that could receive a further boost if the recently announced infrastructure plan from the Biden administration is passed.8

Source: State Street Global Advisors, FactSet, as of April 1, 2021 based on the holdings of the S&P Kensho New Economies Index. *Growth is measured by the growth of the median company in the subsector. Characteristics are as of the date indicated, are subject to change, and should not be relied upon as current thereafter. EPS growth estimates are based on Consensus Analyst Estimates compiled by FactSet. 

Source: State Street Global Advisors, FactSet, as of April 1, 2021 based on the holdings of the S&P Kensho New Economies Index. *Growth is measured by the growth of the median company in the subsector. Characteristics are as of the date indicated, are subject to change, and should not be relied upon as current thereafter. EPS growth estimates are based on Consensus Analyst Estimates compiled by FactSet. 

Putting up stats at the start of the season
Earnings season is upon us and expectations are high. Yet, they are coming off significant downside revisions that were overly pessimistic. So, the catch up we are seeing is not a large surprise. And figures could be even stronger than currently estimated today after all firms report, given the strong number of beats over the prior two quarters that were also preceded by upbeat estimates, as discussed earlier.

Overall, investors will want to keep an eye on the box score during the first quarter earnings season to discern if firms can deliver on the growth expectations and keep this streak going for another month. As it stands right now, cyclical sectors may lead on beats given the strong sentiment and their more constructive starting valuations.

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