The earnings per share (EPS) for all S&P 500 companies combined increased +0.52% this week to $185.01. The forward EPS is now +16.34% year to date.

About 25% of S&P 500 companies have now reported Q1 results. 85.4% of those companies have beaten earnings estimates, and combined earnings have come in +22.9% above expectations. (I/B/E/S data from Refinitiv)

The S&P 500 index declined -0.13% this week.

The increase in the EPS (+0.52%) plus the decrease in price (-0.13%) for the week, pushed the price to earnings (PE) ratio down slightly to 22.6x

The earnings yield for the S&P 500 is 4.43% compared to the 10 year treasury rate of 1.56%. Just in terms of valuation, fixed income still offers little competition to stocks.

Economic data review

The Conference Board’s Leading Economic Indicators index (LEI) increased +1.3% in March (the highest monthly growth rate since August), while February’s number was revised lower from 110.5 to 110.2. All ten indicators within the index increased in March.

“The improvement in the U.S. LEI, with all ten components contributing positively, suggests economic momentum is increasing in the near term. The widespread gains among the leading indicators are supported by an accelerating vaccination campaign, gradual lifting of mobility restrictions, as well as current and expected fiscal stimulus. The recent trend in the U.S. LEI is consistent with the economy picking up in the coming months, and The Conference Board now projects year-over-year growth could reach 6.0 percent in 2021.”

The LEI is now about 0.50% away from making a new all time high.

March new home sales came in at 1,021,000, a gain of +20.7% for the month. Gains were pretty solid across all regions and February numbers were revised higher, from 775K to 896K. You have to go back to August 2006 to find a higher monthly number. New home sales have historically been a pretty reliable leading indicator, so a new cycle high for this expansion bodes well.

The March new home sales number is +66.8% higher than the prior year's results. You’d have to go back to January 1992 to find a higher annual growth rate.

Notable earnings

Netflix (NFLX) reported Q1 results this week, with adjusted EPS coming in at $3.75, which was above estimates and +137% above last years results.

Revenues came in at $7.16 billion, a record high, and a growth rate of 24% year over year and 7.8% sequentially.

Operating income came in at $1.7 billion, an all time high, and operating margins jumped from 16.61% in Q1 2020, to 27.36% in Q1 2021. The margin expansion came from an increase in gross margins, from 37.6% to 46.0%, and reduced spending on marketing, from 8.7% of sales to 7.2%, along with minor improvements in tech & development and G&A spending as a percentage of total revenues. Part of the margin expansion has to do with delayed production costs due to COVID restrictions, but the margin improvements aren’t just a COVID phenomenon. The trailing twelve month (TTM) operating income trend has been moving sharply higher for the last few years now.

TTM Net profit margins now come in at 14.24%, an all time high. The company’s increasing profitability was noted, “we believe we are very close to being sustainably FCF positive and that we no longer have a need to raise external financing to fund our day-to-day operations.”

Now to the bad news. New subscriptions for Q1 came in at 4 million, which was well below the company’s guidance of 6 million, and the company guided Q2 net subscriptions of only 1 million, which would be one of the lowest quarters ever. It’s clear a lot of future growth was pulled forward last year, and increasing competition won’t help matters either.

Netflix’s income comes exclusively from streaming subscriptions, so it only has two choices to increase growth. 1) increase subscriber base, and/or 2) raise prices. It looks like subscriber growth will be limited for the foreseeable future, so that leaves price increases. But raising prices may only worsen the subscription growth situation.

Netflix does deserve inclusion to a portfolio IMO. It’s a fantastic company that’s becoming more profitable each day. But the tough year over year comparisons and competition in the streaming space makes me question the future growth rate, and therefore question the current valuation (current forward PE is 56x). I cut positions in half during the failed breakout attempt after reporting Q4 results in January.

The stock gapped down below its 200 day moving average after reporting earnings and remained below even during Friday’s rally. The relative weakness feels bearish. If the stock can’t stay above the 200 day, its likely to retest the bottom of this trading range around $460.

Were would I be looking to add back to full position? Around $440 would get me interested, there is a major swing high at $423, and it would match the 26% decline in March 2020. $390 would be the next area of interest, there is technical support there and would match the 35% decline in 2019. I have no idea if price will get that low. Otherwise I’ll maintain half size positions in the stock for the foreseeable future.

Chart of the week

This weeks chart is the updated world economic growth projections from the IMF. They now expect global growth of 6%, which would be a 50-year high. I think this will benefit those holding a diversified portfolio. In Q1 we saw market returns come from international, small cap, and value stocks, while large cap growth (tech) lagged behind as we adjust to the new normal.

Summary

2021 earnings growth is currently projected to be +30% (highest since 2010) and rising, while companies are beating earnings expectations by a record amount. To put this in perspective, since 1994 the average earnings beat rate is about 65%, and results come in about 3.5% above expectations. The Q1 beat rate is currently 85% and results are coming in 23% above expectations. Valuation is still reasonable and the economy looks poised for record growth. So far the bond market seems to be taking the great economic data in stride, with interest rates remaining in negative territory when adjusting for inflation (real rates).

The market declined about 1% on Thursday when Biden’s capital gains tax increase proposal was announced. First off, as of right now its just a proposal. The slimmest majority in the Senate means this process is likely to result in a compromise of some sorts. Taxes are going up, the question is by how much. I suspect this is a negotiating tactic, start high and find a compromise somewhere in between. We’ll see.

I don’t see these proposals as changing the fundamental picture in any significant way, but it could have a short term affect on sentiment/valuation. If this is an area of concern for you, its time to assess your time horizon. If your time horizon is 5+ years, meaning its money you don’t need anytime soon, then this issue can be ignored.

Next week will be extremely busy. 173 companies (roughly one third of the S&P 500) will be reporting earnings, including all the big technology names. The list of earnings I’ll be paying attention to is too long to list. For economic data we have consumer confidence on Monday, FOMC statement on Wednesday, our first look at Q1 GDP on Thursday, and core PCE on Friday.