The macro backdrop in the US have improved leaps and bound across the first half of this year, but how has it stacked up for earnings of the S&P 500 companies? Read more to find out.
- iFAST Macro Research Team
- Published on 25 May 2021
- The US 1Q21 earnings season has been overwhelmingly positive so far. Among which, 87% have reported positive EPS surprise (actual EPS beating analysts’ expectations), coming in way above the 5-year average of 74%.
- Earnings also exceeded consensus forecast by 23% on aggregate – extending a fourth quarter of the massive EPS beat we have witnessed in the S&P 500 Index since Q2 last year.
- Looking ahead, we continue to expect robust momentum in upwards EPS revision for US equities (S&P 500 Index), given the promising first set of quarterly earnings. Consensus EPS estimates were revised by +13.8% and +9.1% for FY21 and FY22 to date respectively.
- Yet, the coming months could be challenging for the US equity markets. US equities’ expensive valuations are vulnerable to inflationary worries; the inflation chatter has resurfaced on the top of investors’ mind after April’s CPI data, which has surprised to the upside.
- We temper our optimism surrounding US equities market and downgrade it to 2.5 Stars ‘Neutral’ rating (from 3.0 Stars ‘Attractive’ rating).
- We recommend a “Buy on Dip” strategy for US equities. Any near-term market corrections could present a window of opportunity to buy into the longer-term secular growth investing offered by exposure to US equities.
With all three major US benchmarks (especially the S&P500 Index) now flirting with record high levels, investors are increasingly divided on where the equity markets will go next.
After all, US equities have performed well relative to global equities to date; S&P 500 Index registered positive total return of 12% (as did Dow Jones and Russell 2000 Index), pushing it firmly in the lead among major markets in terms of performance. The S&P500 Index has edged up another 6% since our last update in March, drawing it ever closer to our target price of 4,400 set for US equities by end 2022.
One of the biggest draws against US equities is their valuations – currently trading at 22.7X FY2022 PE – which is both expensive relative to history, as well as that of other markets.
But we argue that P/E valuation multiples are likely to contract ahead as the earnings denominator increase – making US equities appear less expensive gradually.
Further upsides for US equities, therefore, lies on earnings to deliver this year – set to grow by at least 34% YoY in FY2021.
How has S&P 500 companies fared in the 1Q21 Earnings season?
The US 1Q21 earnings season is almost over and the result has been overwhelmingly positive so far.
Overall, 95% of all S&P500 companies have reported actual results for Q1 2021 earnings season to date. Among which, 87% have reported positive EPS surprise (actual EPS beating analysts’ expectations), coming in way above the 5-year average of 74%. According to FactSet, it also marks the highest percentage of S&P 500 companies reporting a positive EPS surprise since 2008 (Chart 1).
Like the previous quarter (Q4 2020), the highest proportion of companies that reported positive EPS surprises comes from the pro-cyclical sectors – Financials (93%), Consumer Discretionary (88%), Communication Services (92%) and Technology (94%); these sectors naturally perform better financially as broad economic activities recover.
Chart 1: 87% of S&P 500 companies have reported positive EPS surprise in Q1 2021 – a record high.
Not only are more companies beating estimates, the magnitude of EPS beat has also been rather significant as well. 1Q 2021 saw earnings exceeding consensus forecast by 23% on aggregate – extending a fourth quarter of the massive EPS beat we have witnessed in the S&P 500 Index since Q2 last year (Chart 2).
Unsurprisingly, the magnitude of the earnings surprises reported was also largest in companies within the pro-cyclical sectors – Consumer Discretionary (59%), Communication Services (37%) and Financials (36%). Together, they also account for the top contributors to the increase in overall earnings for the index since the end of the first quarter.
The impressive earnings season for Q1 2021 also marked the highest year-on-year earnings growth (54%) reported by the index since Q1 2020 (55.4%). This abnormally high growth rate was partly attributable to the low base effect in Q1 last year, caused by the negative impact of COVID-19 on various US industries (Chart 3).
Chart 2: 1Q 2021 saw earnings exceeding consensus forecast by 23% on aggregate
Chart 3: Q1 2021 also marked the highest year-on-year earnings growth for S&P 500 since 2010.
Firms with greater overseas sales exposure saw higher revenue growth in the Q1
Delving under the hood,interestingly, we noticed that S&P 500 companies with larger international revenue exposure were doing better in sales than the rest. Despite the uneven global economic recovery from Covid-19, these companies outperformed those with more domestic revenue exposure in revenue growth for the first quarter.
Based on data compiled by FactSet, companies with more than 50% international revenue saw blended revenue growth of 16.2%, almost double (8.9%) that of those with greater domestic revenue exposure (less than 50% international).
At the sector level, the outperformance of S&P 500 companies with larger international revenue exposure is even more distinct – led by growth-oriented Technology and Communication Service sectors. These two sectors, which include Tech giants with the likes of Netflix and Apple – key beneficiary of the digital/Stay-at-home economy, were the largest contributors to the 16.2% revenue growth rate for S&P500 companies with more than 50% overseas revenue exposure (particularly Asian oriented ones).
While dispersion in revenue growth between sectors were wide, earnings growth was less so.
Among the domestic-driven sector, Financials (Banks to a large extent) were the largest contributor. Despite a revenue growth of only 3%, earnings growth was over 250% in Q1 – US banks were reporting substantial year-over-year decreases in provisions for loan losses. This significantly boosted earnings despite having no impact on revenue.
This meant the S&P 500 companies were able to tap on the stronger Asia growth backdrop (due to its better Covid-19 management), while waiting for its own economy to shake off the damage caused by Covid-19 pandemic last year.
What does 1Q 2021 earnings implies? (Hint: More positive EPS revision to be expected)
Looking ahead, we continue to expect robust momentum in upwards EPS revision for US equities (S&P 500 Index), given the promising first set of quarterly earnings.
Our optimism in earnings recovery momentum across 2021 is backed by two major reasons.
For one, as the US economy reopens and the reflation continues, we expect significant improvements in revenue and earnings among the cyclical sectors to continue across the upcoming quarters, especially those that derive bulk of their sales domestically. Consumer cyclical Industries like transportation, travel and leisure, retail and restaurants will benefit from an impending consumption boom in the US – led by a combination of pent-up demand, massive fiscal stimulus and the USD 2 trillion in excess household savings.
At the same time, the Financial sector (Banks) are poised to see stable top-line and bottom-line growth via improving credit environment to drive loan growth and net interest income.
Secondly, secular growth-driven sectors like Technology and Communication Services will also continue to benefit from the digitalisation of the economy and accelerating consumer trends (e.g. remote working, rising penetration of eCommerce and eServices into daily life) across the globe.
With much of these sectors’ earnings generated internationally, we believe the synchronised global growth backdrop of 2021 will bode well for these sectors. Not only will revenue growth likely be maintained at robust double-digit pace, profitability is also set to improve – ultimately driving a substantial portion of S&P 500 aggregate index EPS growth.
Indeed, Wall Street analysts appears to share the same sentiment. Consensus EPS estimates have since been revised by +13.8% and +9.1% for FY21 and FY22 respectively, as our fellow analysts turning more bullish amid a successful vaccine roll-out, ultra-accommodative monetary policy, injection of fresh fiscal stimulus, alongside the nationwide re-opening earlier this month (Chart 4).
Accounting for both consensus and our own EPS revisions, US earnings are projected to grow 35% in FY2021, followed by 17% in FY2022 – growth rates last seen in the aftermath of 2008 GFC (the prior economic cycle) (Chart 5).
Chart 4: Analysts turning bullish – consensus EPS estimates were revised by +13.8% and +9.1% for FY21 and FY22 to date.
Chart 5: US earnings are projected to grow at pace typical in the aftermath of a major recession
Are all the good news priced in?
Despite the impressive Q1 earnings, market reactions have been rather muted. In the last two months, S&P 500 companies that beat consensus expectations saw smaller change in prices, and those that missed were heavily punished.
Are all the good news priced in? We would think so.
In our view, there is two major reasons for such a cold reception in the market.
Firstly, Q1 earnings marked the fourth consecutive quarter of exceptional earnings surprise. Market participants may come to expect such strong outperformance and are increasingly desensitised towards it – rendering each positive EPS surprise less impactful.
Secondly, the optimism surrounding a rosier macro and growth backdrop appears to have priced in to the elevated valuations of US equities.
After all, valuations are indeed expensive; S&P 500 index is now trading at PE ratio of 22.7X FY2021 EPS (19.0X FY2022 EPS) – higher than both its 10-years average as well as our fair PE ratio of 20.0X (Chart 6).
Price multiples (across various measures) are also expensive relative to other major markets, with P/E ratio, P/B ratio and EV/EBITDA ratio comparatively higher than that of its peers (Chart 7).
Not only does the expensive valuation meant limited room for upsides (from re-rating), looking ahead, valuations are likely challenged by inflationary worries. The inflation chatter has resurfaced on the top of investors’ mind after April’s CPI data, which has surprised to the upside.
At the same time, Fed may start to discuss about tapering of asset purchase in its upcoming June’s meeting (as suggested by the April’s meeting minutes). Growth equities with “long duration” attributes may be beaten down once again as concerns surrounding the tapering (of asset purchases) rachets up – not unlike what we have witnessed between late February to March this year. This could lead to choppy price actions in US equity markets entering 2H21.
Chart 6: Expensive – S&P 500 index is now trading higher than both its 10-years average and our fair PE ratio.
Chart 7: Price multiples are also expensive relative to other major markets
US: Challenging in the near-term, but “Buying on Dips” likely a winning strategy
As we have argued in our previous articles on US, EPS growth – not valuation re-rating – is now firmly in the driver seat for US equity market.
In fact, S&P 500 Index has been trading above 22.0X PE since May 2020 a year ago – but that didn’t impede the equity market’s blistering 38% ascent since.
Ultimately, the robust EPS growth (+35% in FY2021; +17% in FY2022) will be responsible in driving much of the upwards momentum in S&P 500 Index ahead (Chart 8).
Fortunately, given the improving growth outlook and the promising Q1 2021 earnings results, we believe the projected EPS growth trajectory for this and next year is very likely to materialise.
At the same time, as earnings improve off the 2020 low base, we could see PE valuation multiples contract as the earnings denominator increases – knocking away investors’ concerns on its valuation.
Chart 8: EPS growth – not valuation re-rating – is now firmly in the driver seat for US equity market this year (possibly next year as well).
That said, however, we are also cognisant that the coming months could be challenging for the US equity markets.
We see two main risks ahead. Firstly, market could easily overreact to the improving Q2 economic prints (due to the low base effect) and sustained inflation overshoot. Secondly, any miscommunication by Fed officials’ on their intent to start tapering asset purchases (or misinterpretation of the intent by market) could see a swift knee-jerk reaction in the equity market –we are nearing the closely-watched FOMC meeting in June.
Applying our fair PE ratio of 20.0X on our adjusted EPS projections for the next two years, we derived a target price of 4,400 for S&P 500 Index by end-2022. This represents a meagre upside potential of +5% from yesterday’s closing price (4,197 points; 24 May 2021). The impressive YTD performance has unfortunately wiped off the allure of US equity market since our last update.
Table 1: Impressive YTD performance has unfortunately wiped off the allure of US equity market since our last update.
|US S&P 500 Index||FY2019||FY2020||FY2021||FY2022|
|PE ratio (X)||25.6||29.9||22.4||19.1|
|Expected earnings growth (YoY %)||0.8%||-14.4%||33.7%||17.3%|
|Earnings Per Share (EPS)||163.81||140.23||187.50||220.00|
|Projected fair price (Based on 20.0X fair PE ratio)||3,276||2,805||3,750||4,400|
|Potential upside (%)||–||–||–||5%|
|Source: Bloomberg Finance L.P., iFAST estimates. Data as of 25 May 2021.|
With an upside potential of only 5% left, we temper our optimism surrounding US equities market and downgrade it to 2.5 Stars ‘Neutral’ rating (from 3.0 Stars ‘Attractive’ rating).
For investors still interested in US equities, we recommend a “Buy on Dip” strategy – accumulating shares as prices decline. Economic and earnings fundamentals are steadily improving, US equities are hamstrung only by their elevated valuations at the current juncture.
Thus, any near-term market corrections of 10-20% could present a window of opportunity to buy into the longer-term secular growth investing of the US equity market.
Table 2: Products that investors can consider for the longer-term US growth investing
|Sector/Product||Active Funds||Passive ETFs|
|Large Cap Growth||Wells Fargo US Large Cap Growth Fund Cl A Acc USD||Vanguard S&P 500 ETF (NYSE.VOO)|