Buyers are in search of readability for the brand new earnings season however are unlikely to get it
People pass a sign to JPMorgan Chase at its headquarters in Manhattan, New York City.
Spencer Platt | Getty Images
Earning season is just around the corner, but traders will be far less interested in the fourth quarter results than they are in the first quarter and second quarter forecasts.
The problem is, it's not clear that CEOs are going to work together.
The banks are strong in the profit zone
Big banks like JPMorgan Chase kick off profitable season on Friday. A good omen: banks are strong in the profitable season.
"This is the first profitable season in recent history that banks have been leaders in the profitable season," said Alec Young of Tactical Alpha.
In fact, a basket of large banks, the SPDR Bank ETF (KBE) is up 30% since the election, far outperforming the S&P 500.
And unlike much of the market, they're not overpriced.
"They have a lot of climbing space, they are not expensive," he told me.
Why do we need guidance now?
"As the earnings season begins and gains momentum, a key factor in the fourth quarter earnings season will be not only how they met, missed, or exceeded expectations for the quarter, but also how reporting company management frames the quarters ahead . " John Stoltzfus from Oppenheimer Asset Management said in a statement to clients.
A strong earnings forecast for 2021 is crucial to confirm the foundation of the rally: this massive incentive combined with an effective vaccine will result in a dramatic expansion in corporate earnings from the first quarter, and especially in the second, third and fourth quarters.
"The S&P is NOT trading in Q4 numbers, but in … estimates for Q3 and Q4 2021," DataTrek's Nicholas Colas said in a recent statement.
S&P 500 result (ests.)
- Q4: USD 36.88
- Q1 2021: $ 37.59
- Q2 2021: $ 40.39
- Q3 2021: $ 44.22
- Q4 2021: $ 45.28
Overall, earnings are expected to rise 25% in 2021, and that's just the current consensus. Many have considerably higher estimates.
The market is already partially reflecting these expectations. The S&P 500 rose nearly 50% from the March 23 low to November 2, the eve of the elections, largely driven by massive fiscal and monetary stimulus. A further 10% has risen since the elections, largely due to the assumption that there will be more momentum and further incentives to invest in clean energy.
"The market will see a significant acceleration in earnings growth due to better than expected operational leverage," Morgan Stanley's Mike Wilson wrote in a recent statement to clients.
Operating Leverage is an accounting term that measures how a company can increase profits by increasing sales.
Put simply, Wilson and other strategists anticipate that US corporations' cost-cutting efforts in 2020 – cutting rents, cutting jobs, and cutting travel expenses – will dramatically improve bottom line results and accelerate corporate profits even further as revenues are expected to rise Year 2021.
More income plus lower expenses mean more profit.
Return to More Normal Revenues for Battered Sectors?
Analysts expect earnings to accelerate significantly towards mid-year, particularly in sectors believed to be the most sensitive to vaccine adoption, such as airlines, banks and energy. UBS strategist Keith Parker noted that forward earnings for this particularly sensitive group were down about 36% from February 2020 to early January but are expected to rebound: "If people get vaccinated, they'll likely be spending on it Areas affected by COVID "normalize" shortly thereafter, "Parker wrote in a note to customers.
The mid-third of vaccine-sensitive stocks also saw profits fall 9%. "So there is ample headroom for gains from stocks negatively impacted by COVID to normalize," wrote in a recent note.
The problem: It's not clear that CEOs are ready to give the all-clear from the second quarter. Many – maybe most – will likely opt out.
"How can anyone in the travel or hospitality industry provide legitimate advice that is not just guesswork?" Nick Raich from Earnings Scout told me. "Companies have been reluctant to provide guidance for some time. The worst forecast was the second quarter of last year. It is improving, but slowly."
Are analysts still too pessimistic?
Another problem: will analysts dramatically underestimate earnings again in the fourth quarter, as in the third quarter? Analysts were caught flat-footed in the third quarter. Corporate earnings were far better than analysts expected due to incentives. The average company beat its earnings estimate by about 19%, well above the normally reported 3% increase.
Analysts again underestimate the strength of Corporate America in the fourth quarter?
Some, including UBS's Keith Parker, say this is the case. This is due to the weakness of the dollar (a big help to those making profits overseas), quarter-over-quarter GDP growth, and a slow increase in earnings revisions in the fourth quarter.
Others note that the easing of stimulus in the fourth quarter coupled with weak employment growth suggests that the bottom line is likely to be far more modest.
So far the news has been encouraging. The small handful of companies that reported earnings (most have quarters that end in November) have exceeded expectations by an average of 13%.
One problem: The market may already be calculating significant profit gains. Parker noted that previous announcements remained unchanged despite a significant increase on average.
Raich noted that it is not uncommon to raise prices when expectations are so high. "We're in the FOMO (Fear of Missing Out) phase, where people are still interested in getting into the market without too much regard for revenue," said Raich.
If we don't get strong forecasts and upward revisions to earnings, this could change quickly.
Subscribe to CNBC PRO for exclusive insights and analysis as well as live business day programs from around the world.