What Corporate Earnings Tell Us About the Economy

Charlie Toole:

Hello, and welcome to another The Adviser You Can Talk To Podcast. I’m Charlie Toole, portfolio manager of the Dividend Income strategy and I’m joined by my colleague, co-manager of the strategy, Steve Johnson. Hi Steve.

Steve Johnson:

Hi Charlie. Happy to be here today.

Charlie Toole:

Well Steve, you and I, and the rest of our team, we’ve been busy the past couple of weeks reading earnings releases, listening to management teams on earnings conference calls. In this podcast, we’ll talk about some of the major themes that we’ve been reading and hearing about. First, I thought I’d start off with a few numbers. We’re about 60% or just under 2/3 of the way through earning season, about 2/3 of the companies have reported earnings. And earnings, depending on where you look, were the down slightly or I know S&P has earnings growth down slightly for the quarter, but I’ve also seen, in FactSet earnings are up 4% on the quarter and Credit Suisse had a report out, their earnings are up 2%.

Charlie Toole:

So, depending on where you look, it’s going well so far, but one of the things that we’ve seen that we typically don’t is when a company reports earnings that are better than expectations, usually the stock price will react positively. And on average, companies that beat earnings are up 1.5% after that earnings report. But what we’ve seen this quarter is companies that are reporting positive earnings surprises, their stock price is falling. It’s down 1% on average. And that’s something that we normally don’t see, right?

Steve Johnson:

Yeah, it’s interesting Charlie, because the market has punished those companies that have beat, and it’s actually, they’ve rewarded those companies that have actually missed estimates. And I think there are probably several different reasons why that’s occurring, but I think it’s also mostly a function of where we’ve been in this market, right? So, you know technology names, Amazon absolutely blew the numbers away, yet the stock price did not reflect the absolute beat. In fact, the stock is trading lower today than when it reported those fabulous numbers. And again, it’s just a case of expectations, right? A lot of that good news is already been priced in the market. Whereas if we look at some of those sectors like energy, like the consumer discretionary in the banks, a lot of those names have actually had some pretty positive guidance, but also have had some positive reaction to their earnings because you know, not a lot of people liked owning energy coming into this year or the banks. Everyone was still focused on those technology names. And I think it’s just really a case of how people were positioned as they came into 2021.

Charlie Toole:

I think that’s a great point, Steve. I think that those sectors that you were just talking about that are under-owned or that people don’t really want to own like energy, banks, those are areas that are beating estimates. And we’ve really seen, I think analysts or the expectations have been too conservative. One of the things we’ve seen here is a lot of companies have beaten their revenue estimates, which isn’t usually the case. We’ve had 75% of the companies that have reported earnings and revenues. Those revenues have beaten estimates. And typically it’s only about 60% to 65%. So, analysts are really underestimating what these companies are earning. And we saw that last quarter, the record for companies beating those earnings estimates or revenue estimates was 80% last quarter. So, coming out of this pandemic, I think analysts and investors are underestimating the strength that this recovery is having.

Steve Johnson:

It’s a great point. We’ve always talked in years past about companies that are beating the bottom line and perhaps they’re doing it through some financial shenanigans or kind of just balance sheet adjustments. But when you look at revenue, that’s a real number, even though the market has not rewarded those companies who have beat estimates as one would expect increasing earnings and revenue growth that we’ve seen this quarter, that does bode well for longer term economic growth, as well as an improving stock market.

Charlie Toole:

Right. I think one of the items or one of the themes that I wanted to touch upon was some of the conservatism coming from these management teams, we’re starting to get some guidance more than we had last quarter. I think you were talking at our meeting earlier today that about 10% or 55 companies in the S&P 500 have provided guidance and that’s rising. But I think a lot of management teams still don’t have a lot of clarity on what they’re going to see this year. And that might be one of the reasons why you’re seeing those positive earnings beats not have a positive stock reaction because management are still tempering expectations because they just don’t have clarity into the second half of the year. We’ve talked about how earnings growth rates are really going to move much higher starting now as we get to easy comparisons from last March and last April. But when we get to the back half of this year, a lot of management teams still don’t have the confidence that the economy is going to be running full strength.

Steve Johnson:

Not without a doubt. I mean, I think you’re seeing it and again, it’s sector related. So, as we’ve seen the airlines, the other industrials, they’re not able to give great guidance going out. Whereas we have seen some of the banks being able to issue positive guidance and also within the sector, within the financials, different companies involved in different parts of the financials are also offering positive guidance. And what’s interesting, Charlie is, to your point about the companies that are somewhat cautious in their predictions for the future, we have seen though it’s about 35 of those companies have issued some positive EPS guidance, which if that were to continue here over the next couple of weeks is significantly above the five-year average. So, last quarter we rarely saw a company be able to give guidance and now we’re actually starting to over the last couple of weeks, really see those numbers ramp up.

Steve Johnson:

And so if that continues and companies are starting to become more positive that will bode well for earnings in the future. Now, of course, we’re also seeing that with the consumer, right? As if we look at consumer confidence, consumers are also becoming a little bit more confident, especially as we’ve seen more and more vaccines being rolled out and over 2 million folks this weekend, getting the vaccine on a daily basis. So, we’re starting to see, I think that optimism slowly creep in to some of these later earnings reports that we’re seeing and you and I, both over this week had a stack of earnings reports and conference calls and believe it or not, we’re actually starting to see more and more of these CEOs, right? Talking about specifically the vaccine and how that potentially may impact their business in the future.

Charlie Toole:

Thanks, Steve. And that’s a great point on the vaccine. I mean, we’ve heard a lot of management teams talk about the distribution of the vaccine being critical for this recovery to continue to gain steam. And when we heard from Pfizer and Johnson & Johnson, they both had very positive things to say about their vaccine. Pfizer has distributed more than 50 million doses worldwide, nearly 30 million here in the U.S. And they’re expecting to distribute more than a billion this year in 2021. And what’s important there is, as this vaccine continues to get distributed, it’s starting with the most susceptible part of the population, the essential workers and people over the age of 65. And as these people are vaccinated and they can start to go back out into the economy and do things, whether it’s going to restaurants, shopping, traveling, these are the types of economic activity that will spur the growth that we’re expected to see in this recovery.

Charlie Toole:

I do want to transition a little bit here. Steve, you mentioned consumer confidence. And I think we’ve seen that in a lot of the reports from the banks and from the credit card companies, we’re seeing these companies release credit reserves and that means that the borrowers from these credit card companies or these lenders they’re paying back or making more payments on their loans. And that’s something that, once a bank or a credit card company releases these reserves that falls right to the bottom line is profits. And we’ve seen that whether it’s American Express, Capital One, JPMorgan, others, a lot of these financials are seeing their customers be able to pay back or service their loans.

Steve Johnson:

Yeah, that has been the one takeaway from the banks. So, not only are the banks doing better now because of the yield curve and that we’re finally starting to see interest rates move higher. But the surprise for this quarter to your point is that, the write-offs have not been that bad. So, you haven’t seen the widespread mortgage delinquencies. You haven’t seen people defaulting on their credit cards. And in fact, Jamie Dimon at JP Morgan was pretty enthusiastic I think for him about the economy and where he saw it in the second half of this year.

Steve Johnson:

And again, I think that’s a trend that we’re seeing across all these different earnings reports is that it wasn’t as bad as people thought. And to your initial point about the analysts getting it wrong, the economy and the earnings have been much stronger than many have anticipated in that worst case scenario that we all thought about over the last couple of quarters, hasn’t really panned out. I mean, you and I were talking not only about the banks, but look at Apple and Amazon and even Microsoft last quarter. It’s just pretty amazing when you look at that, how well that even those companies have done.

Charlie Toole:

Absolutely. It’s a great point. Both Apple and Amazon had a $100 billion in sales in the fourth quarter. So, that’s not just one, it’s two companies that exceeded a $100 billion in revenue. And I think Steve, you mentioned earlier today that the big five tech companies exceeded a trillion dollars in revenue for the year, which is just an absolutely astonishing number. So, it’s speaking to some of the themes that we’ve seen throughout 2020 where those large-cap techs have dominated stock performance, and you can see why there’s a fundamental reason for it, they’re earning large sums of money,

Steve Johnson:

They certainly are. In fact, in the journal this weekend had amazing statistic that now their market cap, Apple, Microsoft, Amazon, and Google, you mentioned the trillion dollars in revenue for companies. They now have a market cap larger than the GDP of all, but 16 countries, $7.2 trillion, which is pretty amazing. And also, I think it gets to the point that we always talk about is valuation. And everyone wants to think that this is the next bubble, that word thrown out every day now about bubbles in the stock market. And yet, if you look at this, these companies are producing at a level that we really never thought could exist. And in back in 2000, we were dealing with companies that couldn’t even come close to matching what these folks are doing in terms of the earnings and the revenue. So yeah, you could argue that are some parts, a little bit overvalued or elevated, but the numbers that are coming through in the earnings, the true earnings have been astounding.

Charlie Toole:

They have. And I think that to your point this is a completely different case from the internet bubble of the late ‘90s. You’ve got these large-cap tech companies are earning large sums of money and in some cases they’re returning that money to their shareholders. Some of these large-cap tech companies are paying dividends and growing their dividends. So, there’s more to these companies than there were 20 years ago.

Steve Johnson:

Well Charlie, Obviously we’ve been pretty bullish so far, right? We’ve talked about the earnings in the revenue beat, the EPS beat, the earnings per share beat, what’s out there though? So, you obviously reading the transcripts, listening to the conference calls, what is out there that may have an impact on earnings going forward later in the year. Is there anything that makes you hesitant or makes you a little bit cautious?

Charlie Toole:

Yeah, I think the one thing that is giving me pause is inflation and like the word bubble, I think inflation is used a lot. And as soon as someone says inflation, everybody immediately goes back to the 1970s and the huge inflation numbers that we have there. I don’t think it’s going to be that type of inflation, but we have seen oil prices rise, we’ve seen corn prices, lumber prices, commodity prices across the board have been increasing. And when that happens, that’s a cost input for these companies. And whether it’s industrial companies like Eaton, who are seeing prices rise in copper and steel, which is a major input into their products or companies like Procter & Gamble and Kimberly-Clark that sell consumer products directly to consumers.

Charlie Toole:

Each of these companies are seeing their input costs rise, and that means one of two things are going to happen. They’re either going to make less money because they can’t raise prices and so what they have left over after this cost inflation is going to be less, or they’re going to increase prices to maintain their profits and that means higher prices for consumers. And either way, as you start to see that matriculate in, I think you might see if companies like Procter & Gamble raised their prices, it’s going to be a hit to consumers’ pocket.

Steve Johnson:

Yeah, that’s a great point. I think, we’ve talked about it in our meetings about also the supply chain disruptions that have occurred because of the pandemic. And also we have seen unit labor costs. So, really just the labor costs going up and so far it hasn’t impacted profit margins that significantly. I think the profit margins are coming in at about the little, actually a little bit better than the five-year average, although they slipped a little bit from where we were a year ago. But I think that’s something that we’re going to look at is we’ve experienced a boom in profit margins, right?

Steve Johnson:

Companies have been able to expand their margins due to technology over the last couple of years, but it’ll be interesting to see over the next, I think six months to a year now is, will companies be able to raise prices in this kind of environment? And we might see a real divergence between those who are successful and able to do so versus those that can’t. And so to your point, exactly, I think inflation, especially commodities, and the move that we’ve seen is pretty important to keep on the radar. Nothing, I think that is that worrisome yet, but it’s definitely something that we’re going to keep an eye on.

Charlie Toole:

Right. And I think that rising commodity prices has an impact on the dollar, or at least the dollar relative to foreign currencies. And we’ve seen the dollar drop more than 10% from its high earlier in 2020. And that’s having an impact on inflation, but it’s also having an impact on companies that sell their products across the world. And so that currency translation can be a positive when the dollar is falling.

Charlie Toole:

Steve, thank you for joining me today. I think the big takeaway from our conversation is that corporate profits are recovering faster than investors and analysts have expected. And that typically leads to higher stock prices. We’ve also heard positive news on the vaccine distribution and consumer financial health, and we’ll be keeping a close eye on inflation numbers and how they unfold in the coming quarters and what that means for corporate profit margins and prices that consumers pay. 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, and your feedback is always welcome. If you have any questions or topics you’d like us to explore, please email us at info@adviserinvestments.com. And before closing, I’d like to thank Kailey Steele and Ashlyn Melvin. They do all the hard work making this podcast possible. Thank you for listening.