S&P 500 Earnings Update

The S&P 500 earnings per share (EPS) increased to $192.56 this week. The forward EPS is now +21% year-to-date, and +50% higher than this time last year. I expect a sizable increase in EPS next week as we roll into a new quarter. Current Q2 earnings growth estimates are now +65%.

The S&P 500 index increased +2.74% this week, for yet another record.

The S&P 500 price to earnings (PE) ratio is now at 22.2.

The S&P 500 earnings yield is now 4.50%. Compared to the 10-Year Treasury bond rate of 1.54%, the index is still reasonably valued.

Economic Data Review

New Home sales for May came in at 769 thousand, down -5.9% from last month (which was revised down from 863 thousand to 817 thousand). This is the second consecutive monthly decline, but it is still +9.2% higher on an annualized basis. The median sales price has now increased +18% year-over-year. In terms of geography, the Northeast led with +33% growth in new home sales for the month, while the South declined -14.5%.

The combination of record high prices for buyers, the increasing costs for builders, and scarce inventories is starting to come through in the data.

The third and final estimate for Q1 Gross Domestic Product (GDP) came in at $19.086 trillion, an increase of +6.4% annualized. The economy has now recovered 91.4% of the COVID-19 recession, -0.8% below the Q4 2019 peak. The Atlanta Fed’s Q2 GDP growth estimate is currently +10.3%. If this number turns out to be the actual result, it would mean the economy has already surpassed the prior peak.

Within the final GDP estimate is my favorite report on US corporate profitability. Corporate profits for all US companies increased $55.156 billion in Q1, to a total of $2.349 trillion, another record high. Representing an increase of +2.4% for the quarter, and +15.45% year-over-year.

The Federal Reserve released results of its annual bank stress test for the 23 largest financial organizations:

“Over the past year, the Federal Reserve has run three stress tests with several different hypothetical recessions and all have confirmed that the banking system is strongly positioned to support the ongoing recovery.”

The hypothetical conditions under which these tests were conducted included a 10.75% unemployment rate, a 4% decline in GDP, and a 55% decline in stock prices. Under these conditions, the losses would bring their capital ratios down to 10.6%, which is still double the requirement held by the Federal Reserve.

Why is this important? Collectively the banks hold tens of billions that would otherwise be payed back to shareholders through dividends and/or stock buybacks. These results all but guarantee financial firms will be allowed to resume those operations in the not so distant future. The financial sector outperformed the index by a factor of 2 this week.

Personal Consumptions Expenditures (PCE) minus food and energy costs (Core PCE) increased 0.5% in May, resulting in an annualized gain of +3.4% (up from +3.1% last month). You have to go back to September 1991 to find a time the Core PCE was that high on an annualized basis. Core PCE is the Fed’s preferred method of inflation monitoring.

This confirms the CPI results, but like the CPI, Core PCE sees much harder year-over-year comparisons going forward. Hopefully we’ve now seen the peak of the growth rate for awhile.

Real personal income excluding government transfer payments rose to a record $14.4 trillion in May, for a gain of +0.45% for the month, and +7.84% year-over-year.

The M2 Money Supply increased +1.2% in May, +13.8% annualized (down from +18% annualized last month). The annualized growth rate in M2 is still above any of the prior highs on record, for the 14th consecutive month. 

The Fed is being disingenuous when it says inflation will be “transitory.” Yes, the inflation rate may have peaked in May, but its very unlikely to return to its sub 2% levels for awhile. The historical average annualized M2 growth rate is 7.1%, so we are still almost double the historical average a year and a half later.

Chart(s) of the Week

Last week we saw how the earnings growth recovery was a global phenomenon. Interestingly, the inflation surge is not. While US core inflation breaches +3%, the Eurozone remains at 1% and Japan continues to struggle with deflation. My guess is that its a result of the US being ahead in the reopening process. Time will tell.

Summary

This week we saw the market quickly shake off the angst from last week's Fed projections. In the end, it all comes down to earnings and interest rates. Record high profitability, plus very low interest rates, are supportive for all risk assets. It’s likely the economy has already surpassed its prior high, and the banking system is in good shape. The next couple of weeks will be relatively slow due to the holiday, and then Q2 earnings will really kick off the week of July 12.

As of now, Q2 is shaping up to be the peak in the growth rate for both earnings and the economy. Expect the question, “is this as good as it gets?” to arise over the coming months. While this might be true, I expect growth to continue well past Q2, just at a more moderate level.

I’m still pleasantly surprised that interest rates have stayed subdued despite the surge in inflation. While I think there is a good chance we have seen the peak in the inflation growth rate, I expect inflation to remain above average for awhile. Earnings are good enough to handle a moderate increase in the risk free rate. And if rates stay below 3%, we may very well be in the sweet spot of solid economic/earnings growth and below average interest rates.

Next week there are five S&P 500 companies reporting earnings. For economic data we have Consumer Confidence on Tuesday, ISM Manufacturing PMI on Thursday, and the BLS employment report on Friday.