Thursday, November 26, 2020

Earnings Matter And They Have Improved Significantly

This week the government released the second estimate of third quarter U.S. GDP at 33.1% growth at an annual rate, unchanged from the earlier advanced estimate. This is a sharp snapback from second quarter's 31.4% contraction. Of course this significant swing is a result of the virus mandated economic shutdown and reopening.

Although virus cases have increased near term, the reopening process continues and is reflected in improved earnings growth as well. With the second reading on GDP the Bureau of Economic Analysis (BEA) reports the underlying detail from the National Income and Product Account, the component detail that goes into the GDP calculation. This week's BEA GDP report shows third quarter NIPA after tax corporate profits without inventory valuation & capital consumption adjustments reached a record $2.1 trillion.

The NIPA corporate profits figure noted in the above chart is the closest to S&P 500 profits. With this in mind, the growth of S&P 500's forward earnings estimate is currently over 18%. The strength of the stock market's return since the March low is in part due to this improved earnings outlook.

Lastly, analyst expectations for expected earnings growth earlier this year were certainly too pessimistic. In addition to the positive impact an improving economy has on earnings growth, these two factors contribute to the highly positive earnings revision ratio, that is, more earnings estimates being revised higher versus being revised down.

In short, the economy is on the mend and provides a foundation for the improved equity market. As a recent report by S&P Dow Jones Indices noted, "the S&P 500®Index is a leading indicator of the performance of the U.S. economy.” As we wrote in a recent report, "Virus challenges remain, yet we believe we are well on the winding Road to Recovery. The American consumer has proven resilient, business leaders have demonstrated creative ability to navigate uncertain times, and a potential vaccine gives rise to hope of further prosperity in the months and years ahead."

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