The U.S. economy and capital markets continue to report positive data and build a fundamental foundation for the pandemic recovery. This week, the July employment report showed the second consecutive month of 900,000+ job gains and a drop in the unemployment rate to 5.4%. Corporate earnings continue to impress as well. With almost 90% of S&P companies reporting their second quarter results, 87% have beat earnings and revenue expectations. 2021 S&P 500 earnings are projected to finish 31% above 2019’s pre-pandemic level. The index is currently 30% higher than where it finished in 2019, signaling those equities may be fairly valued with more room to run.
Back in early July, we put together a corporate earnings season preview as the focus of our Weekly Strategic Insight. Now that we are through the bulk of second quarter earnings season (nearly 1,400 companies have reported earnings since July 1st including 443 of the S&P 500), it is a good time to review the data for company and stock performance trends.
Overall, it has been a strong reporting period in terms of results. Through Friday, August 6th, of the 443 companies in the S&P 500 Index that have reported earnings for Q2 2021, 87.4% reported earnings above analyst expectations and only 9.7% reported earnings below analyst expectations. In a typical quarter, 66% of companies beat estimates and 20% miss estimates. If the 87% earnings beat rate holds through reporting season-end, it will mark the highest percentage of S&P 500 companies reporting a positive earnings per share (EPS) surprise since FactSet began tracking the metric in 2008. In aggregate, companies are reporting earnings that are 16.4% above estimates, which compares to a long-term average surprise factor of +3.9%.
We have previously noted that analysts have consistently underestimated reality during the COVID pandemic recovery period. To that end, over the past four quarters, 83% of companies beat estimates and 14% missed estimates, while the average surprise factor was +20.1%.
As for top line revenue growth, 87.1% reported revenue above analyst expectations and 12.9% reported revenue below analyst expectations. In a typical quarter, 61% of companies beat estimates and 39% miss estimates. Over the past four quarters, 74% of companies beat estimates and 26% missed estimates. In aggregate, companies are reporting revenues that are 4.6% above estimates, which compares to a long-term average surprise factor of +1.1%, and the average surprise factor over the prior four quarters has been +3.5%.
The most recent projections of annual corporate earnings growth are +44.9% for 2021 and +9.1% for 2022. That kind of growth is hugely supportive for equity markets and valuations. The most recent forward price-to-earnings ratio stands at 21.3x, which is elevated above the 25-year average of 16.7x, but below levels from February of this year.
Stock Reactions to Earnings
While companies’ reported performance has been exceptionally strong, their stock performance has not always been commensurate on reporting days. Looking at the S&P 1500, which offers a broader view, the 1,101 companies that have topped EPS forecasts have averaged a one-day gain of 0.93%, while the 1,130 companies that exceeded sales estimates have gained an average of 0.78% on their earnings reaction days. That’s a solid but not exceptional reaction from market participants.
What appears to be receiving more consideration is forward guidance. Companies that have raised guidance have gapped up an average of +1.95% and then climbed an additional 0.70% during trading for a full one-day gain of 2.67%. The “triple plays”, or the 240 companies that have beat EPS and sales estimates PLUS raised guidance, saw an average opening gap of +2.27% followed by an intraday gain of 0.78% for a full-day gain of 3.07%.
The most important economic release on this week’s calendar was the July employment report. On Friday, the U.S. Bureau of Labor Statistics reported that total nonfarm payroll employment rose by 943,000 in July, beating economists’ expectations. Also, May and June employment figures had significant upward revisions of +31,000 and +88,000, respectively. The result was a decline in the headline unemployment rate of 0.5% to 5.4%.
Notable job gains occurred in leisure and hospitality, local government education, and in professional and business services. Leisure and hospitality have now added back almost 79% of the jobs lost in March and April of 2020 during the depths of the pandemic.
Interest Rate Reversal?
The U.S. large stock indexes hit fresh all-time highs on the blowout jobs report, which reflects a broadly favorable fundamental backdrop, even as COVID risks persist. Maybe more interestingly, interest rates increased on the news.
The 10-year U.S. Treasury yield rose again and now stands more than 0.15% above its low from earlier in the week. That may seem like a small move, but interest rates have been in a downtrend since the end of March. With a couple of key inflation indicators coming out next week and little in the way to ease supply shortages and inventory drawdowns, price increases are unlikely to show a meaningful slowdown, which could push yields higher.
If interest rates do continue to move higher, it is natural to expect some stock sector rotation. Earlier this year, the technology sector showed a clear inverse correlation with interest rate moves. That was on display again on Friday. As the 10-year Treasury yield rose 0.07%, the NASDAQ declined 0.40% while the Dow gained 0.41%.
The sectors most positively correlated to interest rates that could stand to benefit from a return to March’s interest rate levels are Financials, Industrials, Materials, Communication Services, Energy, and Consumer Discretionary. Although not a sector, small cap stocks also show a positive correlation during a rising interest rate environment.
Have a great Sunday!
Timothy W. Ellis, Jr., CPA/PFS, CFP®
Senior Investment Strategist, Wealth Strategist