US companies are setting foot on the road to profits recovery.
The consensus prediction is that, in the first quarter, earnings per share will increase 35 per cent from the same period last year. Revenues, analysts say, will be 10 per cent higher than in the first three months of 2020.
These forecasts are very encouraging, but expectations for some individual sectors are better still. Analysts have particularly high hopes for the cyclical parts of the market – areas such as consumer stocks, financials and resources. It is worth noting, though, that while some of the numbers put forward look remarkable, they owe much to the scale of last year’s collapse in economic activity.
Who will point the way?
Earnings season is now in full swing. As always, some of the big banks were among the companies to report early. Analysts’ rightly predicted that strong trading activity, combined with freed-up loan reserves, would boost profits.
Many lenders made considerable provisions in case the loans they made in the early heights of the Covid-19 crisis went bad. Their planning turned out to be too pessimistic, however, as many companies that had taken loans subsequently received government support, meaning they did not have to default.
In the fourth quarter, we saw some of the big banks begin to release their reserves. Early indications from the likes of JP Morgan, Wells Fargo and the Bank of America are that this process continued between January and March. There were also hopeful signs of improved trading numbers among investment banks. Goldman Sachs said it has seen more activity in both its fixed income and equity divisions. Analysts expectations were once again too pessimistic as 90 per cent of companies in the financial sector have recently exceeded recovery projections (and by a very high margin).
Meanwhile, many investors will be asking what news from big tech and the other mega-cap companies? This week started off with the releases from Tesla, and will be followed by the announcements from Microsoft, Alphabet, Apple, Facebook and Amazon to finish off what will be the busiest week of this earnings season.
A high bar to pass
With vast majority of companies crashing Q1 estimates so far, simple headline EPS ‘beats’ have not always been sufficient to deliver strong share price response
In each of the past three quarters, earnings per share at the majority of reporting companies were higher than the forecasts. The trend of earnings surprises is even stronger than the one we saw during the recovery from the global financial crisis. Simply put, the bar for unforeseen good news is very high.
A recent survey from BoA Merrill Lynch demonstrates this point well. It found that 85 per cent of institutional investor respondents expect corporate profits to improve over the next 12 months. This is a far higher number than we normally see from this survey.
Earnings revisions, or the changes that sell-side analysts make to forecasts they have already made, are also running hot. For several months, upgrades to predictions of future earnings have outnumbered downgrades by a large margin. As a result, investors have become inured to such positive ‘surprises’. We might, therefore, not see a corresponding jump in share prices when these numbers are released.
Why we shouldn’t keep staring in the rear-view mirror
Earnings season should be as much about looking ahead as behind. For investors, this means paying attention to companies’ forward guidance, as well as their past quarter results.
While recovery prospects loom large, there are still challenges ahead. Some of the biggest companies in the technology, media and telecoms sectors benefited hugely from the lockdown environment. As their customers’ time (and wallets) moved online, their profits flourished. But can these companies sustain the trend once economies fully reopen?
There are also legislative changes to consider.
It is true that US President Joe Biden’s infrastructure stimulus plans could create winning stocks in some sectors. But some businesses might find themselves funding the spending.
The Made in America document, recently published by the US Treasury, points to more fairness in taxation. Biden aims both to fund his generous stimulus package and to redress the balance. He wants to do so by tackling tax evasion at large multinationals. If his plans make it through Congress, such changes could have a big effect on certain companies that have been deemed to be making abnormal profits.
Looking at corporate America’s way ahead, there might be bumps in the road, but new routes could also be about to open up.
It looks like there will be several quarters of strong profit, though this is likely to be concentrated in certain sectors. This should create opportunities for investors in the months to come.
Karolina Noculak is investment director, multi-asset investment, at Aberdeen Standard Investments
