Profit Growth – February 16, 2021

Still-low interest rates, fiscal stimulus and talk of more stimulus, new vaccines, and economic growth have been credited for the stock market’s powerful performance. While they have all played an important role, profit growth is now coming into play.

 

We are well into Q4 earnings season, which is usually defined as the S&P 500 companies that have been reporting results for the final three months of the year.

Let’s briefly dive into the numbers. With 74% of S&P 500 companies having reported through February 12, profits are expected to rise 3.4% versus one year ago, according to Refinitiv (projections are subject to change as the remainder of the season progresses).

While 3.4% growth doesn’t sound impressive, S&P 500 profits had been forecast to decline by 9.8% in early January, just as companies were beginning to report Q4 results. That’s significant.

It’s even more impressive given that the economy has yet to fully recover to pre-pandemic levels. Another way to look at it: economic activity is still below one year ago using U.S. Gross Domestic Product as the benchmark (U.S. BEA data). But S&P 500 profits are up.

Wall Street vs Main Street

Why have profits outpaced economic activity? The S&P 500 Index is an unmanaged index made up of 500 large U.S. companies. It’s well diversified across the major sectors in the economy.

But these are big U.S. companies, and the pandemic has disproportionately hurt smaller, serviced-based firms.

William Lazonick, an emeritus economics professor at the University of Massachusetts at Lowell, told the Washington Post in December, “This is a global crisis, but the big companies are not treating it as one — they haven’t skipped a beat.”

Some industries have done exceedingly well amid pandemic-related distortions that have hurt some firms but have helped others. For example, we see benefits accruing to some technology firms and companies that are deemed essential.

But spending at local restaurants, theaters, sporting events, and travel remains under pressure.

Meanwhile, analysts, who have traditionally been conservative with their estimates, failed to factor in the strong economic bounce into forecasts. Cost-cutting is also playing a role.

As we look to 2021, analysts have been raising earnings forecasts. Of course, anything more than a few months into the future gets increasingly murky. And much will depend on how the overall economy performs.

Created 2021-02-16 18:00:03