The first quarter earnings season is picking up speed this week. Analysts believe S&P 500 companies’ earnings rose around 27 percent in the three months to March, compared to a year earlier when the pandemic rocked corporate earnings.
Companies like Netflix, AT&T, and American Express are expected to release results this week, providing a relatively broad view of the state of American businesses in the early days of a potentially strong year for the US economy. This could also help set expectations for the stock market as early as this year after a major rally.
The consensus among 76 economists polled by Bloomberg is that gross domestic product will grow 6.2 percent in 2021, which would make it the best year for economic growth since 1984. Given the strong economic situation, the mood among stock market analysts is almost generally optimistic.
“You’d have to be fooling yourself to expect US companies to be overall below consensus, given the macro backdrop is such a good driver of revenue,” wrote John Vail, chief global strategist at Nikko Asset Management.
Expectations for earnings growth are even higher for the current quarter: Analysts assume that companies in the S&P 500 will see earnings up 54 percent year-on-year in the three months to June.
This surge, of course, reflects a recovery from the worst of the pandemic’s breakout. But it is also a result of the “economic acceleration and a recovery in commodity prices,” said Jonathan Golub, a stock market analyst at Credit Suisse.
Of course, if everyone expected such a surge in earnings, the good news could already be fully incorporated into stock prices – and that means anything but perfect results would mean a difficult stretch for stocks.
This was certainly the case with some banks that reported profits last week. For example, Morgan Stanley shares fell on Friday despite record sales and earnings for the bank. On Monday, investors hailed the better-than-expected results for storage company Prologis in the same way.
The S&P 500 has already risen by almost 11 percent in 2021 and hit another record high on Friday.
That could mean that the market is going to retreat anyway. The index is relatively expensive by metrics such as price / earnings ratio, which compares stock prices as a percentage of expected corporate earnings over the next 12 months.
The S&P 500 is trading at almost 23 times its expected profit. That’s roughly the rating the index held for most of the past year, but very high by historical standards.
Over the past 20 years, the S&P 500 has traded an average of 16 times expected profit.
In comparison, a valuation of 23x expected earnings is closer to the valuation of the equity markets at the end of the dot-com bubble in the late 1990s. When that ended, the S&P 500 fell around 50 percent before bottoming out.