Profits ripping

I have noted many times recently that profits are set for a tearaway year in 2021 owing to a combination of massive stimulus, massive cost-cutting, massive demand recovery and a massive inventory cycle. BofA gives a good take on the launch pad:

What recession?

4Q earnings are now up YoY vs.-2.5% in GDP Corporate earnings have defied a shrinking economy: 4Q EPS for the S&P 500 is now up 0.3% YoY vs. -2.5% YoY in GDP. Performance can differ as well (e.g. last year), and this year we are neutral on the S&P 500 despite +6% GDP expectation. Inside we revisit the differences between the S&P 500 and the US economy:

1) S&P earnings are more correlated to global GDP than US GDP, with ~30% of sales overseas (though this could shift again amid peak globalization);

2) earnings are more geared towards business spending/goods, whereas consumption/services make up nearly 70% of the US GDP;

3) operating leverage–historically, every 1% move in GDP has translated to a ~3.5% move in EPS;

4) >1/3 of earnings are TMT, whereas the“digital economy” is estimated to be <10% of GDP; 5) earnings are exposed to inflation (both pricing and cost), while headline GDP numbers are real; and

6) macro sensitivities (higher oil and a weaker dollar are typically positive for earnings, negative for GDP).

For greater economic sensitivity, we would tilt toward small caps, which are poised to benefit more from this year’s recovery.

A robust 14% EPS beat; earnings grew in 7 of 11 sectors

292 S&P 500 companies(78% of earnings), have reported so far, and 4Q EPS has jumped to $42.11–14% above consensus. Earnings beat in all sectors except Energy, with Financials, Consumer Discretionary, and Communication Services all beating by >20%. Earnings grew YoY in seven of 11 sectors (Energy, Industrials, Real Estate and Utilities declined), with the biggest growth coming from Materials (+17%) and Financials (+16%). The proportion of beats has also been one of the strongest in history: 66% beat on both sales and EPS, just shy of 67% we saw last quarter, which was the record high (vs.38%on average). Guidance continued to come in strong, with 4.5x more above-consensus guidance vs. below so far in February (Chart 10), highest since October 2020.

Still limited reward for beats

The lack of reaction from beats this quarter is one sign of a euphoric market: companies that beat on both sales and EPS underperformed the S&P 500 by 22bps the following day, the worst reaction in history. Reactions have improved (though are still tepid) the last two busy earnings week, with15bps and 33bps of alpha in Week 3 and Week 4, respectively, vs.-198bps in Week 1 and-209bps in Week 2.

It is my view that the profits boom has another year to run and, although the inflation panic will no doubt come, it will more likely than not represent a buying opportunity.

So long as the virus is contained by vaccines.