Blockbuster Earnings, Monster Recovery?

Charlie Toole:

Earnings are growing at over 50% and companies are beating estimates by the highest amount on record. Is this the beginning of a hot summer for investors or is this as good as it gets? Hello and welcome to another Adviser You Can Talk To Podcast. I’m Charlie Toole and I’m joined by my colleague, Steve Johnson. Hi, Steve.

Steve Johnson:

Hi, Charlie.

Charlie Toole:

We are the co-managers of the Dividend Income Strategy. And like we’ve done in quarters of the past, our team has been busy over the past few weeks listening to earnings calls, reading earnings releases. And in this podcast, we’ll talk about major themes we’ve been reading and hearing about.

So Steve, let’s jump right in. Last quarter, we did the same thing, we started with some basic numbers on what’s going on out there in earnings land. And so far, we’ve had about 60% of the S&P 500 reporting earnings. And according to Bloomberg, earnings growth rates are running at 50% over last year. It’s been better in some of the cyclically sensitive areas of the market, so materials are up over 109%, consumer discretionary 130%, and financials led by banks up 140%. So we’ve seen a lot of growth, a lot of recovery. And we talked about this before, that we’re getting to a point where we’re comparing to the depths or the worst of the coronavirus pandemic last year and we’re seeing a very strong recovery across the market.

Steve Johnson:

Yeah, it’s been phenomenal. If you look at how well those sectors that you mentioned have done—so as we know the stock market’s a leading indicator, so those sectors have led in 2021. We’ve seen energy, we’ve seen financials, the industrials, and the consumer discretionary all lead the market. And part of that is because people were thinking that these earnings would be better than expected. And it has been, I think, probably better than what even I expected. You were talking about some numbers there, we’re looking at almost 90% of the companies that have reported have beat their estimates. And not only have they beat their estimates, but they’re beating them by a huge margin. I think the average here is on a beat is 23%. And to put that in perspective, over the last five years, the average beat has been around 6%.

Steve Johnson:

So you’re seeing some numbers that are extraordinary, whether it be the likes of Amazon that reported earnings of $15 a share when the analysts were looking for $9, Discover Financial, Goldman Sachs, Goldman reported $18 versus the estimate of $10. So it’s amazing, Charlie how strong they have been but also how wrong, and we’ve talked about this a lot of times, but how wrong the analysts were in predicting what those earnings would be this quarter.

Charlie Toole:

Right, that’s a great point, that’s where I wanted to pivot to next. Analysts are usually and typically pessimistic coming out of a recession. And we talked last quarter, in January, earnings for Q1 the estimates were being increased by analysts by I think 3%, 3.5%. And that was at the time one of the highest readings on record. And to your point, those results have been that much better, 22%, to 23% better. Well, we’re seeing the same thing unfold this quarter. In April, estimates for Q2 were up more than 4%, or increased more than 4%. And that’s the highest reading since this stat has been tracked going back to 2002. So on average in the first month of a quarter, analysts decrease their estimate earnings by 2%, and we’ve seen them increase in by 4%. So it’s just a case where you have so much pessimism coming out of a recession and you can’t see or can’t forecast how strong the recovery is going to be.

Steve Johnson:

That part has been extremely interesting to watch over the last month. Because when we came into 2021, the analysts were looking for a total earnings on the S&P 500 of around $167. That number, just in the last month alone, has now gone to $186. I’ve read several different analysts and different chief strategists, some of them actually are as high as almost $200 for this year. So that gets us to, when you and I always talk about valuations, that valuation question, people have said, “Well, markets must be very expensive.” But if we’re looking at that important number, that next 12 month number, if you look at that and we do get that kind of earnings growth, where the S&P is now, you’re talking 20, 21 times, then perhaps it’s not as expensive as what a lot of people thought when we entered the year.

Charlie Toole:

Great point. And people I think are starting to expect more growth even after that, which can, if you get out in further quarters and further years, you see that earnings growth recover and the valuation doesn’t look as bad.

I wanted to pivot, we talked about the easy comparisons to last year. And one of the things that we’ve heard some companies talk about, and we always talk about the consumer, but there were some stats or some data from companies, JP Morgan, Visa, Discover, these are credit card companies so they have their finger on the pulse of what the consumer is doing, they were actually talking about the growth over 2019 levels.

Charlie Toole:

So JP Morgan saw consumer spending up 14% over 2019, Visa saw volume and transactions 16% higher than 2019. And Discover was seeing some strong growth even just in March over February, travel spending. So as people are getting the vaccine, as people are more comfortable going out and we’re getting more vaccinated people in the population, travel spending was up 75% year over year in March and that number was down 50% year over year in February. So you’re seeing a big acceleration in a lot of what the consumer’s doing. And that’s a good thing, not only for corporate earnings but for our economy.

Steve Johnson:

Well, we’re seeing that. And this is a huge week too, not only for earnings, but also for the economic data. You’re going to look at retail sales this week, I think they could be up over 45% year-over-year. So of course we’re dealing with very low numbers last year, a very easy comparison, but still those retail sales were extraordinary. In Friday of this week, we’re going to be talking about the unemployment and the jobs number. And some forecasters are saying for a million jobs being created this week and over that last month period. So you are seeing the recovery I think speed up, and we’ve seen that in the earnings.

Steve Johnson:

And in fact—look at guidance. So last year, or even last time you and I were doing this, we didn’t see a lot of companies issue guidance at all. Now not only are we seeing companies issue that guidance, but it’s been positive. In fact I think it was like 30 of the 48 companies that issued guidance, they issued positive guidance, which that number is almost double of what we normally see in a quarter. So those numbers that you mentioned about the recovery, they clearly have translated into earnings and as well into the market. I guess the question that you and I look at is, we know the market’s a leading indicator. Despite the great earnings, the results have[n’t] been great? The stocks, they haven’t performed as well after those numbers.

Charlie Toole:

No, that’s a great point. And it gets me thinking of the question: Is this as good as it gets? Are we seeing the peak? We’re certainly seeing peak in base effects or comparisons to last year. So you’re going to see numbers that are off the charts, we mentioned the 75% or the 100%-plus growth rates—but is this as good as it gets? And do people start to get overconfident or overexcited about what’s going to happen in the future? And is that going to be a headwind for the stock market?

Steve Johnson:

Yeah, I think you’ve nailed it right there. Because last year we were questioning, like, “How can the market do so well when the economy is struggling?” And now we’re saying, “Gosh, how could these companies—Amazon reported a number that was just extraordinary, Apple the same earnings, great number—and yet the stocks are down anywhere 5% to 10% off of their highs from when they reported. And what we’re seeing is that this quarter those companies that beat their earnings they have trailed the S&P by very small amount, it’s not that noticeable. And companies that have missed or down relative to the S&P 2% to 3%. So I guess that is the question and that’s the one that I think you and I will be looking at over the next few months for sure.

Charlie Toole:

Good. So I do want to transition to another topic that we’ve talked about a lot on the investment team, we’ve had a lot of questions about it from clients, and it’s been probably the number one topic in the headlines over the last two to three months, and that’s inflation. We’ve had any commodity from oil to corn to lumber, which I think is up four fold from a year ago. So we’ve had prices rising and we’ve heard a lot of management teams on these conference calls talk about how it’s going to impact the cost structure. And a lot of management teams have basically said they’re going to raise prices on their products. So they’re going to pass through that inflation to their customers. And that’s something that we’re expecting to see in the months ahead.

Steve Johnson:

Without doubt. Transitory or not.  It’s the question every time you hear that phrase, “transitory,” we’ll see. But to your point, we listen to these conference calls, we read the transcripts, Procter & Gamble in their earnings this quarter, they’re now really raised their forecast of costs by $400 million. Through shipping, through commodity costs, a lot of different input they’re seeing. Now, fortunately the larger companies, they’ve been able to pass that through and so what we’ve seen is margins. So margins are at all time highs now for companies, so that inflationary pressure has actually translated into better profits. The question is, if this continues for longer, what happens? Will the consumer be able to absorb those prices?

Steve Johnson:

You mentioned lumber, every day, you’re seeing things on Twitter about prices of lumber. We’ve seen house prices up, the average home I think up $13,000 in the last 12 months, partly due to the cost of lumber. And so at some point that will have an effect on housing. And as I always like to say, the cure for high prices is high prices. And so at some point we might have a negative impact based off of this kind of inflationary pressures we’re seeing. But I guess the question is, and what we will continue to monitor, is that ongoing debate versus, is this a one-time issue that we’re going to see through the summer but then resolves itself in the fall as the economy opens up, supply chains improve? Or is this something that the Fed is behind the curve on and that we start to see this extend a lot longer than what many people think?

Charlie Toole:

Well, transitory or not, when a company raises prices, they typically don’t cut them once inflation goes away. So higher prices will be here for consumers, I don’t see companies cutting prices if inflation is transitory. I think one of the big things, we were talking about this yesterday, is the supply-demand issue. We’ve talked about the chip shortage before, we also had that ship get caught in the Suez Canal which really disrupted global shipping, and then just with the pandemic, we’ve had certainly higher demand as people were able to continue to work from home, which was something unique to this recession. But because of the shutdown, a lot of the supply chains weren’t able to run at full capacity. So you had lower supply, at least stable if not increased demand, and that is creating this imbalance. Whether it’s in the semiconductor chip sector or just across the commodity space, you’re getting the supply-demand imbalance, which is causing this inflation.

Steve Johnson:

Yeah. Ford said that, Ford said they’re going to have a hard time meeting their production goals in the back half of this year. Caterpillar with a very similar story regarding their production. So it’s definitely having an impact, at a time when, to your point exactly, demand is off the charts. We’re seeing used cars up, I think the price was up over 50%, used car prices over the last year. And then we looked at the number of vehicles being sold in April, hitting records here. So to your point, we are seeing that demand and there just isn’t enough supply at this point.

Charlie Toole:

No. And what we’re hearing from the semiconductor companies is they’re trying their best to increase supply. But companies like Qualcomm said they’re hoping to end these supply constraints by the end of the year. So this is not something that’s going to be solved in the next month or two, this is going to be something that we’re going to see throughout the year.

All right, Steve, I think we’ll leave it there. Thank you for joining me today. I think the big takeaway from our conversation is that corporate profits are growing like gangbusters, but we’re watching out for if this is as good as it gets. Our country is going to be fully vaccinated—or at least anybody that wants a vaccine will have access to it—so the second half is going to be a year where the economy will be fully opened.

Charlie Toole:

We’ll keep an eye on how the inflation numbers unfold and what that means on profit margins for these companies and prices for the consumer. So this has been Charlie Toole and Steve Johnson from Adviser Investments, thanking you for listening to The Adviser You Can Talk To Podcast. If you’ve enjoyed this conversation, please subscribe and review our show. You can check us out at adviserinvestments.com/podcasts. Your feedback is always welcome. If you have any questions or topics that you’d like us to explore, please email us at info@adviserinvestments.com. Before closing, I’d like to thank Ashlyn Melvin. She does all the hard work making this podcast possible. So thank you for listening and thank you, Ashlyn.