Weighing The Week Ahead: Can Earnings Growth Justify Current Stock Prices?

glass walled high rise building

We have an array of interesting data in the week ahead including inflation news, more employment numbers, and sentiment from consumers and small businesses. Most importantly, we have the start of earnings season.

Despite this, the political story will dominate, at least for a bit longer. While this is newsworthy, it is not the key element for investors. What best depicts this challenge to find the right focus?

Let us turn to Chance the Gardener. The simple-minded gardener who knows only what he has learned on television is a fount of wisdom.

Chance the Gardener : As long as the roots are not severed, all is well. And all will be well in the garden.

President “Bobby” : In the garden.

Chance the Gardener : Yes. In the garden, growth has it seasons. First comes spring and summer, but then we have fall and winter. And then we get spring and summer again.

President “Bobby” : Spring and summer.

Chance the Gardener : Yes.

President “Bobby” : Then fall and winter.

Chance the Gardener : Yes.

Benjamin Rand : I think what our insightful young friend is saying is that we welcome the inevitable seasons of nature, but we’re upset by the seasons of our economy.

Chance the Gardener : Yes! There will be growth in the spring!

From one of my all-time favorite movies, Being There, with Peter Sellers as Chance the Gardener. Everything about this movie is excellent, and you will see parallels to modern times.

For our purposes, the theme of optimism versus current facts is on target. In my last post I asked what we might expect by Springtime. Making this more specific (and less symbolic than Chance’s version), we should wonder: Can earnings grow enough to validate current stock prices?

Last Week Summary

In my last installment of WTWA, I summarized the long list of uncertainties and asked what more we would learn in the next few months. While this was not the theme for the punditry, we will find it to be a useful reference.

Key Charts

I always start my personal review of the week by looking at some great charts. This provides a foundation for considering news and events. Whether or not we agree with Mr. Market, it is wise to know his current mood.

I am featuring Jill Mislinski’s chart of the market week. Her approach combines several key variables in a simple readable format.

Sector Trends

Sector movement is another important clue to market trends.

Once again, Juan Luque provides us with some words of wisdom from the Incline trading desk:

In the first week of 2021 the S&P 500 posted a new record high with over a 1.8% weekly return. Investors see with positivism the ratification of Biden as the new elected President and the Democrats gaining control of the senate, because of the prospects of additional stimulus. The big mover in the past weeks is the Energy sector. It is clear how it moved through the lagging quadrant and is fast approaching the leading quadrant with weekly gains of 8.52%. The Real Estate sector has reversed its momentum and fell into the lagging quadrant with a 2.38% loss for the week. Health Care was another big winner slowing down its path towards the lagging quadrant. Finally, the Financials sector had a terrific week with gains of 6.24% and is speeding along the leading quadrant.

Comment

The market gained 1.8% on the week with a trading range of 4.5%. You can monitor the continuation of lower volatility in my Indicator Snapshot, featured in the Quant Corner below.

Noteworthy

The Visual Capitalist has an interesting look at the performance of various asset classes in 2020. You get the drawdown, annual performance, and increase from the low in a single chart.

The News Overview

Each week I break down events into good and bad. For our purposes, “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too.

My continuing assessment is that many of the normal economic indicators are not helpful in the wake of the COVID lockdown decline. Too many sources are focused on a change in direction, even if very modest, which has painted an overly optimistic picture. As the economy stalls, there will be a rapid switch in the diffusion indexes. The early signs are emerging. I expect some dramatic shifts over the next month or so.

Good

COVID-19 Vaccines

  • Vaccination has become a reality. Almost 19 million doses have been delivered, including seven million in the U.S. (Bloomberg)
  • The pace, however, is disappointing to most.

  • Expanding eligibility is a possible solution. President-elect Biden is planning to accelerate first doses before some recipients have had the second dost. Gov. Cuomo is acting to avoid unused or destroyed vaccine. Even this approach may not be completed until April.

Earnings Expectations

  • Analyst expectations are rising in contrast to the usual pattern. John Butters (FactSet) reports that this is the second consecutive quarter of increases. He writes:

In a typical quarter, analysts usually reduce earnings estimates during the quarter. During the past five years (20 quarters), the average decline in the bottom-up EPS estimate during a quarter has been 4.5%. During the past 10 years (40 quarters), the average decline in the bottom-up EPS estimate during a quarter has been 4.2%. During the past 15 years (60 quarters), the average decline in the bottom-up EPS estimate during a quarter has been 5.2%.

  • Stock prices have outstripped earnings gains since the start of 2017 reports Brian Gilmartin.
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Disclosure: This material has been distributed for informational purposes only. It is the opinion of the author and should not be considered as investment advice or a recommendation of any ...

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