High US earnings trend points to strong recovery

High US earnings trend points to strong recovery
REUTERS/Carlo Allegri/File Photo

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.