November 21, 2020

If You Thought 2020 Was Surprising… Wait until 2021!

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Bottom Line:


COVID metrics have quickly redlined back to April levels.  However, rather than collapse 40% as the Dow Jones Industrial Average did in March, the Dow this week hit an all-time high.  Simply put, with a vaccine only weeks away from initial distribution, it’s time to look past the pandemic.  While investors were obsessed over politics and pandemics in 2020, investors will refocus on fundamentals in 2021.  They will like what they see.  The US economy went through a rapid “creative destruction” refresh this year.  The mass adoption of transformative technologies and the surge in entrepreneurship will accelerate labor productivity, GDP growth, profit margin expansion and earnings growth.  While 2020 will forever be remembered as a year of relentless negative surprises, 2021 should restore balance as a year of relentless positive surprises.  Now… place your bets!


Full Story:


News of viable vaccines powered the markets higher early in the week, only to lose altitude after some vigilant civil servants started re-powering down America.  They have a point.  COVID case counts have hit record levels, hospitalization rates now exceed April highs and death rates have doubled off of their October lows.  The R0 (how many people one person infects) ratio in most jurisdictions sits at critical levels, foretelling higher infection rates still.  Remember that 60 million Americans caught the swine flu in 2009.  So far, 12 million Americans have caught COVID.  This pandemic hasn’t ended. In fact, it’s accelerating.  And yet markets seem intrepid.  Yes, investors know that an effective vaccine will enter distribution shortly, and yes, they know that constituent pain prompts further stimulus relief, and yes, they know that interest rates pegged at zero force return seekers into the stock market. But there is another, more durable reason for capital’s current courage… corporate earnings.


Companies across the S&P 500 earned $163 in 2019.  For 2020, analysts expected S&P 500 companies to earn $175.  COVID had other plans.  Analysts now expect 2020 earnings of $139.  For 2021, analysts expect earnings of $169, for a year-over-year gain of 22%.  Sound too good to be true?  It may not be good enough.  The below chart chronicles the difference between analysts’ earnings estimates per quarter and the actual results.  As you can see, the past two quarters have registered the highest net earnings surprises on record:




Now don’t confuse earnings surprise with earnings growth.  S&P 500 earnings fell 35% in Q2 and 6% in Q3, so things aren’t good – but they are the best they have ever been relative to expectations!  Why?  First, during times of economic disruption and transition, it’s hard for Wall Street analysts to accurately forecast earnings.  This explains the larger net surprise readings in the chart above around the 1987 crash, the 1990 recession, the 2008 great financial crisis and the recovery in 2009.  What’s unprecedented about the COVID recession era is that earnings NEVER negatively surprised. Analysts wildly underestimated the resilience and ingenuity of their coverage universe and now lag badly behind reality.  With corporations dramatically reducing financing costs, eliminating travel, trimming real estate footprints and rapidly adopting productivity-enhancing technologies, margins, and therefore earnings, should surge as post-COVID revenues return.  For smaller companies, these gains have been even more dramatic relative to expectations.  In fact, for the current quarter, while the net earnings surprise for large companies (S&P 500) approximates 20%, it approximates 75% for small companies (S&P 600).  Across the spectrum, COVID has created the fastest corporate “upgrade” cycle ever.  In economics, they call this rapid reengineering “creative destruction” as new processes and new ways of thinking spread like wildfire through an economy.  For evidence that this economy has entered a substantial upgrade cycle, consider the historic level of new business originations:


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Entrepreneurs start businesses out of necessity or opportunity.  Either way, to be competitive against incumbents, they have to offer something novel.  Additionally, entrepreneurs begin businesses without the drag of legacy systems or legacy thinking.  Historically, a surge in entrepreneur activity leads to a surge in productivity, which leads to a surge in GDP.  If GDP estimates are too low, then revenue estimates are too low, and if profit margin estimates are too low then earnings estimates are way too low.  Once analysts begin catching up with this, earnings estimates will rise.  When earnings estimates rise… markets rise.  And based upon the recent panic buying…we are not the only ones aware of this:




Have a great weekend!



David S. Waddell 
CEO, Chief Investment Strategist


David Waddell
Author: CEO Chief Investment StrategistAfter graduating from the University of the South with a BA in Economics, David began his career with Charles Schwab & Co., Inc. in Phoenix, AZ. Having been recognized for his outstanding business development record, David was promoted to the San Francisco- based Institutional Strategic Accounts Team, which interfaced with the Big 5 accounting firms and Schwab’s largest customers. David left Schwab to continue his education at the graduate level in Boston. While earning his MBA degree with a concentration in finance and investments at the F.W. Olin School at Babson College, he was appointed by the college Trustees to manage a team of seven portfolio managers overseeing the student-managed portion of Babson’s endowment fund. David also founded the Babson Investment Management Association to assist undergraduate and graduate students with training and career path planning in the investment management field. As the firm’s Chief Investment Officer, David chairs the W&A investment committee and combines macro economic forecasting, macro market analysis and macro risk assessments to design portfolio strategies utilizing public market securities worldwide. A civic leader in Memphis, David currently acts as Chairman of Epicenter Memphis, and Co-Chair of the Memphis Chamber Chairman’s Circle while also serving as a board member for LaunchTN and the New Memphis Institute. David previously served as chairman for The Leadership Academy, the RISE Foundation, and the Economic Club of Memphis. He also chaired the capital campaign to build the “Live” stage at the Memphis Botanic Garden. David was a member of the 2004 Leadership Memphis class and has been recognized as one of Memphis’ “Top 40 under 40” by the Memphis Business Journal, and as a finalist for “Executive of the Year” in 2007. In addition to weekly columns in the Memphis Daily News and the Nashville Ledger, David has appeared in the Wall Street Journal, USA Today, Forbes, Business Week, Investment News, Institutional Investor News, The Tennessean and Memphis Business Journal. He has also made appearances on Fox Business News, Yahoo Finance, Bloomberg TV, CNBC, and CBS News and ABC News Channels. Read some of David's articles on his author page in Inside Memphis Business. David has two wonderful children, Easton and Saylor, an obedient Labradoodle named NASDAQ, and a devoted Goldendoodle named Ripley.


David S. Waddell


Chief Investment Strategist

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