ECONOMIC COMMENTARY

CIO Update: Understanding the surprising factors in play during this earnings season

As macro forces continue to play a stronger role in market performance, corporate earnings have become a less effective barometer of share price movement. This week, Chief Investment Officer Shannon Saccocia examines the current factors impacting stock prices and discusses where investor opportunities may be during the back half of 2021. Listen now.


Audio transcription

Hello and welcome to Boston Private Perspectives. I'm Shannon Saccocia, Chief Investment Officer at Boston Private.

I want to thank you as always for joining us. With the month of January now behind us it seems fitting that we should shift our attention to something that normally would demand the bulk of our focus in the first half of the quarter, which is corporate earnings season.

Well admittedly the emphasis over the last few years has shifted to more of a macro focus with the Fed, Washington and the pandemic all significantly impacting market movements, it’s important to get a pulse check from companies in order to understand what we should expect over the next several quarters. Rather than bury the lead, I'll start off with the basic facts. Earnings season for large U.S. companies is going great by almost any measure. Especially given that we are still in the midst of a global pandemic that we have yet to contain.

With just under 60% of the S&P 500 having now reported, the blended earnings growth rate for Q4 stands at 1.7%.

At start of the fourth quarter, earnings we're still expected to decline by almost 13% and were still expected to decline by almost 9% before the end of the quester.

Now I know what you're gonna say, earnings are usually better than expected with around 75% of companies over the long term beating consensus estimates on a quarterly basis. Companies generally got a bit conservative and more importantly analysts are continually fine-tuning their estimates right up until the earnings release thus incorporating any significant events before the earnings drop.

But this quarter 81% of companies reporting thus far has beaten estimates and they're beating by a greater margin. Surprises sit at 15% over consensus, which is well above the five-year average of a little over 6%.

Some of the takeaways include better credit quality, rebounds in ad spending, strength in areas of manufacturing. But perhaps most importantly is that the sentiment seems to have improved over the course of the quarter. Estimates have continued to be pushed up as in analysts are resetting their expectations for the back half of the year and they're now looking for what could be over 20% growth in earnings year-over-year for the first quarter. Which is sharply higher than it was even a few weeks ago.

So with that as the backdrop, you could ask what's happening with stocks. To be candid, the big beats really haven't been rewarded in the markets. And in fact, the companies that have been missing, seem to be getting dinged by investors less than they have historically.

Part of this is likely attributable to a run up and some of the strongest names ahead of their earnings announcements. The typical buy the rumor, sell the news story we've heard so many times before from Wall Street pundits. We saw this in particular for many of the large-cap growth names which released extraordinarily strong earnings and revenue.

And yet still saw their stocks trade either flat or down on the announcement. This is somewhat concerning as it relates to the performance of the overall index, as we talked about over the last couple of years, there is significant concentration in several of the top 10 names; many of which are associated with growth and or momentum factors which have outperformed over the last couple of years. And so whenever moving into the earnings reports of these stocks that represent a large percentage of the index, there is a significant amount of emphasis put on those results by investors and so any meaningful weakness after those reports can potentially impact the index in a disproportionate way.

That's not the only reason that people are paying attention to these earnings reports, however. Companies like Apple and Microsoft are companies that all of us use in our day-to-day lives, they represent the consumer economy for many of us. They represent what we believe are companies that can continue to grow and thrive against a number of different economic backdrops as they have done over the last year. And so they have taken the place in portfolios as being somewhat defensive during very difficult period. And so as such, we do still have a significant uncertainty as we move forward over the next couple of quarters, despite the fact that we’ve seen progress on the vaccine front.

The economy is not yet fully recovered and we're not sure if the pace of the recovery is going to be as strong as we have anticipated or if we are going to be beset by a slower recovery such as the one that we experienced in 2009 and 2010. Which would certainly be a disappointment as it relates to investor expectations and economist expectations at large.

The other thing to consider is that some of the companies that have been missing on their earnings are companies which have felt much more pain from the pandemic and the misses could be viewed just as a continuation of the bad news which has clouded the outlook for these companies over the last year.

A tough earnings report can also be the opportunity for investors to add some more to their positions or initiate new positions in some of these more cyclical sectors and industries and potentially rotate their portfolios for this expected economic break out the back half the year.

So while we don't see a binary rotation from growth to value such as the one that we were talking about say in late 2019 or perhaps in mid-2020 when the COVID-19 situation seem to be improving markedly prior to the second surge, we do believe there does tend to be and does seem to be this incremental rotation into more cyclical exposure. It's been more pronounced in other parts of the market.

We have seen investors potentially add cash from the sidelines or rotate from their fixed-income exposure into areas like small-cap stocks or emerging market stocks which have more cyclical bias in the underlying indices and in the underlying a stock universes but we could continue to see that at the US large-cap level incrementally as these companies are viewed as more attractive following a difficult earnings report.

The sentiment too overall for these companies has been more positive. If you look back and you anchor yourself to where we were in March and April of last year and you look at where we are today, the restrictions that are put on the economy from a social perspective and from a travel perspective were certainly less than we were experiencing a year ago. And many of these companies understand that while the manufacturing side of the economy has improved more quickly, that follow-on consumer recovery is likely to come in the back half of the year and therefore CEO and C-Suite sentiment is more positive if still somewhat cautious.

So if you look at the first quarter and it's difficult to extrapolate what happens in the first quarter through the rest of the year but in this case given the backdrop that I just outlined, it's important to state how these expectations fit into our thesis.

As I mentioned in last week’s podcast, corporate taxes could hit earnings later this year which could push PEs even higher. And interest rates could force investors to discount future earnings at a higher rate and thus create a lower intrinsic value for stocks. But improving topline revenues and continued cost cutting and rationalization could certainly offset these impacts. The variability though could be significant and so our range for earnings this year is pretty wide.

We can see anything from you know 170 to 190 using 2022 EPS forward estimates and that could translate into really a 20% decline to a 20% increase in the S&P 500 for this year if you're using a very broad fundamental range. However given the simulative tail winds that are in place and the reality that fundamentals have proven to be less important than macro forces that have been play over the last couple of years, we view the probability of a modest a strong positive return as higher than that negative return scenario.

There are certainly several things that could upset that outlook for this year. We could see another surge of COVID-19, we could see an acceleration of mutations and a number of different variances where the current vaccines proved to be even less effective and then they are being seen to be versus say the South Africa variance that we’re seeing today.

That would certainly create more concern about a consumer recovery in the back half of the year. We could see policy changes. The Fed could potentially raise interest rates, given what we think will be likely modestly higher inflation. If they view that to be sustainable inflation, they could raise interest rates faster than expected. We could see the tax impact that we talked about last week or we could potentially see Washington determine that they want to be less accommodative.

That seems unlikely, particular given the route that President Biden looks to be going down in order to get his new $1.9 trillion stimulus package passed through just a simple majority by his party. But these are things that could impact those corporate earnings coming into the back half of the year.

And so in short it’s important to continue to look at what's happening at the company level, it's important to be able to understand what's happening from an industry perspective and translate some of the economic data that we're seeing that has been somewhat lackluster into what could potentially create this inflection point mid-year to be able to support a higher valuations, higher earnings and frankly gains in the stock market as we move into the back half of the year.

Thanks again for listening to this week’s podcast. I want encourage all of you to reach out to our team here in Boston Private with any questions or concerns you may have. If you have any questions or thoughts on my points today, you can find me on Twitter @ShannonSaccocia. You can also read our latest perspectives on the markets, the economy, taxes, estate planning and the year ahead by visiting bostonprivate.com. And if you want all of this information delivered right to your inbox, I encourage you to sign up for our newsletters while you’re there. Be sure to subscribe to the Boston Private Perspectives on Apple podcast, Spotify or wherever you prefer to listen. And I look forward to coming to you next week.

Shannon Saccocia, CFA, CIMA®

Shannon Saccocia serves as Chief Investment Officer at SVB Private, and is responsible for setting the overall investment strategy for the firm. She oversees the asset allocation, research, portfolio management, external manager search and selection, portfolio implementation, trading, and investment risk management functions.

The views expressed in the article are those of the author and/or person interviewed and do not necessarily reflect the views of SVB Private or other members of Silicon Valley Bank and SVB Financial Group. The materials on this website are for informational purposes only, are subject to change and do not take into account your particular investment objective, financial situation or need. Since each client’s situation is unique, you should consult your financial advisor and/or tax planning professional before acting on any information provided herein