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Stock markets have entered May in buoyant fashion, building on already impressive gains since the start of the year. Economically sensitive shares have staged strong recoveries after several years of relative disappointment and the technology sector – in the doldrums in February – is back in vogue.
In the US, competing ends of the stock market – as represented by the Dow Jones Industrials Average and technology driven NASDAQ – are both trading close to their previous best levels¹. Whether you chose stocks at the start of the year positioned for the “Biden boom” or for the ongoing march of new technologies, you should have enjoyed another period of respectable returns.
That’s unsurprising, given the continuing rollout of vaccines and the passing of historically significant government bills aimed at bolstering households and industry. Economic growth forecasts for this year and next have been revised up over recent weeks for a world intent on delivering an economy that is at least as robust and sustainable as the one that went before².
Everything looks rosy in the earnings garden except for one thing. With the notable exception of the UK among major world stock markets, valuations – as measured by share price divided by company earnings – are towards the high end of their normal ranges. This could mean markets have factored in unrealistic expectations about how much businesses will earn in future (share prices are too high); or it might mean markets are quite rightly discounting a large future rebound in earnings (earnings are only temporarily depressed).
So can the current earnings season help solve this puzzle? Well, with the bulk of corporate results for the quarter now in, a couple of significant points have emerged.
First, companies have beaten expectations again. In itself, this isn’t all that unusual or remarkable. Many businesses have become adept at being conservative ahead of results hoping for their stocks to benefit from positive surprise, and analysts’ estimates are often at the thinner end of reality. Moreover, last year’s historically significant economic contraction has few precedents in recent times, so estimates gauging the bounce back were more of a shot in the dark than usual.
Even so, the sheer number of businesses bettering expectations has been impressive, as has the degree of the beat. As of the start of this month, around 86% of S&P 500 companies had surprised positively, with earnings 23% higher than expected. Over the past five years, US companies have surpassed earnings estimates by an average of 6.9%³.
Second, absolute comparisons with the first quarter of 2020 have also been noteworthy, particularly bearing in mind that earnings for part of that quarter were unfettered by lockdowns and social distancing. For the 60% or so of S&P 500 companies that have reported so far, earnings were up by around 46% last quarter compared with 2020. Upcoming quarterly results seasons are set to show even starker variations between where we were and where we are now⁴.
Even more impressive results look likely to emerge in Europe and the UK, where analysts now expect earnings to have bounced back by 83% in the first quarter. Of the 157 Stoxx 600 companies to have reported so far, 74% of them have bettered expectations⁵.
There is though just a hint that markets, if not analysts, were already up to speed. Shares in Apple have fallen back since the company announced knockout results – US$24 billion in profits on record revenues of US$89 billion – just over a week ago⁶. A similar fate was lying in wait for Pfizer last Tuesday, as news of a 47% increase in earnings on revenues of US$14.5 billion along with significantly upgraded forecasts for the next quarter failed to lift the company’s stock⁷.
In Europe too, better than expected quarterly results and positive outlook statements from the likes of BASF, LVMH and Nestlé have been met with relative indifference. Nestlé shares, for example, are still down since the company unveiled in late April a “blowout” quarter with sales rising at twice the expected rate⁸.
All this suggests that speculative anticipation in markets does not require the hard facts of a corporate results season in order to blossom. It happens well in advance of positive news, and it often takes really special results to move a share. Having said that, for long term investors, whether the cart or the horse arrives first should ultimately make little difference.
The post-pandemic earnings recovery is clearly already advanced – notably so in the US, where the earnings for S&P 500 companies are already close to completing a “V” shaped recovery spanning just over one year. Analysts have earnings pencilled in for this year significantly above 2019 levels⁹. With the release of pent-up consumer demand still to fully show itself once social restrictions are at an end and government stimulus programmes yet to take full effect, current stock market valuations may turn out to have been a bit less out of kilter with reality than we might have feared they were.
1 Reuters, 05.05.21
2 IMF, April 2021
3 FactSet, 30.04.21
4 FactSet, 30.04.21
5 I/B/E/S data from Refinitiv, 06.10.20
6 Apple Inc., 28.04.21
7 Pfizer Inc., 04.05.21
8 Bloomberg, 06.05.21
9 FactSet, 30.04.21
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon Overseas investments will be affected by movements in currency exchange rates. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to a Fidelity adviser or an authorised financial adviser of your choice.
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