When the Rubber Meets the Road

Top Takeaways

• Q1 S&P 500 earnings are expected to increase by 24.5% YoY
  • Earnings expected to show largest YoY growth rate since Q3 2010 (34%)
• Analysts revised Q1 estimates higher by a record 6.5% since the beginning of the quarter
  • Only the fifth time a positive intra-quarter revision has occurred since 2010 vs. an average decline of 5.1% over the last 15 years.
• Record number of positive pre-announcements
  • Percentage of positive pre-announcements are nearly two times normal levels -
    64% vs. 35% 5 yr. avg
• Annual earnings expected to rebound 26.3% following an 11.2% decline last year
• Capital Return Programs and guidance coming back

What will investors be listening for on Conference Calls?

• How did business trend throughout the quarter? Did this differ across geographies?
• What assumptions are embedded in guidance?
• Has demand shifted as a result of stimulus?
• What are your expectations for additional stimulus or tax changes? How is this affecting business decisions?
• How are you managing inventory levels? Have there been any supply chain disruptions?
• Are margins being pressured by cost inflation associated with raw materials, logistics or wages? How are you mitigating these?
• How would a rising rate environment affect your business?
• How have strategic changes to the business over the last year positioned the company going forward?
• What does the capital return program look like on an ongoing basis?
• How is the company thinking about the post-pandemic workplace/workforce?
• How are ESG issues impacting strategy?

Setting the Stage - A look back at Q1

It was one year ago that the world would forever change as the Covid-19 pandemic spread around the globe. This brought with it the most abrupt economic fallout in history as global economies ground to a halt. US equity markets suffered their fastest, and what turned out to be the shortest lived, bear market in history all within the same quarter. The one-year anniversary of the market bottom was on March 23^rd and as Q1 wound to a close US equity markets completed their fourth consecutive quarter of gains, closing at a new all-time high. At the end of the quarter the S&P 500 was up 5.8% and was ~81% off of the lows.

This year’s first quarter was quite different than last year but was tumultuous in its own right with an insurrection of the Capitol, an arctic storm that left millions without power and a short squeeze of epic proportions. The pillars of the rally - stimulus, vaccines and improving economic data - have remained in place. The rotation into cyclicals/value stocks that began in Q4 last year has also persisted but it has been a rockier road for growth/value stocks as 10yr yields nearly doubled in the quarter. The rise in rates has sparked inflation concerns but the Federal Reserve has been steadfast in its view that this will be “transitory” in nature and has maintained its accommodative policy stance. As the vaccination process has begun to accelerate new challenges have arisen with supply chain shortages, the prospect of higher taxes and growing geopolitical risks. However, pullbacks have been short-lived, and the market has continued to climb the wall of worry.

Inside the Numbers

• Q4 S&P 500 earnings grew ~4% YoY as 79% of companies beat analyst estimates by ~15% snapping 3 consecutive quarters of declines
• Earnings estimates troughed in the middle of Q2 last year and have been moving higher since
• Q1 earnings are projected to increase 24.5% YoY with revenues projected to grow 6.4%
  • As of last Friday, there have been a record number of positive pre-announcements which outpaced companies issuing negative guidance by nearly two to one
    • 64% of companies issuing positive guidance vs. 5yr average of 35%
  • Pre-announcements and positive analyst revisions have pushed quarterly estimates higher by a record 6.5% since the start of the year, versus an average 5.1% decline over the last 15 years.
    • This is the third consecutive quarter we have seen this dynamic but it is only the fifth time since 2010 that this has occurred.
• Companies have steadily been reinstating guidance over the previous three quarters - a trend that will likely continue.
• Corporations have also restored capital return programs
  • S&P senior index analyst, Howard Silverblatt, expects 2021 buybacks will hit $674B this year up 30% from 2020
  • Q4 buybacks were up ~28% QoQ but remained 24% below 2019 levels
  • The Federal Reserve lifted bank buyback restrictions in Q1

The Big Picture
2021 earnings are expected to rebound ~26% from last year’s levels but more impressively this is ~10% above 2019 levels. Part of the acceleration is attributable to the swift action taken by management teams at the start of the crisis to cut costs and react to the change in consumer/customer behavior. This will provide companies with additional operating leverage as the economic rebound continues to accelerate. Estimates for 2022 have also moved higher with analysts currently projecting 15% earnings growth next year. The two big stories of Q1 were the rise of interest rates and the continued outperformance of cyclical/value stocks. Energy and financial sectors were the two best performing sectors in the market and also saw the largest positive earnings revisions which highlights the importance of this dynamic.

Expectations have clearly risen ahead of the quarter. Inflation concerns are emerging which along with supply chain issues may begin to pressure operating margins. Given the continued positive pre-announcements and results from companies that report early in the cycle it appears that this will be another strong quarter from a statistical perspective. The big question is whether companies will be able to offer enough positive commentary to continue to push estimates higher going forward. The next hurdle for many companies will be meeting these expectations as the re-opening becomes a reality not just something that we talk about.

Data compliments of FactSet Earnings Insight as of last Friday.

• If actual Q1 earnings grow by 24.5% YoY it will be largest increase since Q3 2018 (+26.1%)
  • 9 of 11 sectors are expected to report earnings growth
    • 4 sectors expected to grow by >20%: Consumer Discretionary (+103%), Financials (+79%), Materials (+46%) and Info Tech (+22%)
    • 2 sectors expected to decline: Energy (-15%) and Industrials (-17%) - ex airlines would be (+9.4%)
• Q4 YoY Revenue is expected to grow 6.4% YoY
• 8 of 11 sectors are expected to report revenue increases
  • 3 sectors with revenue growth >10%: Info Tech (+15%),
    Consumer Discretionary (+15%), Communication Services (+12%)
  • 3 sectors with revenue declines: Energy (-6.3%), Industrials (-3.3%),
    and Real Estate (-0.6%)
• 2021 EPS estimates: +26.3%, Revenues +9.7%
• 2022 EPS estimates: +15%, Revenues +6.6%
• Double digit earnings growth expected in every quarter this year peaking in Q2
• Valuation: Forward 12-month P/E ratio is 23.5, above the 5yr avg. of 17.8
  and above the 10yr avg. of 15.9