Last week, I ran into full-on hail and got sunburned all in the same day. If you live anywhere in a temperate climate zone, you probably can relate to this meteorological joie de vivre of spring.
I feel pretty much the same about the markets right now. They’re muddling through their own “temperature changes.”
2021 kicked off with a boom in “reopening” stocks. The market was so obsessed with recovery I didn’t hear a single Wall Street analyst root for tech. But in March, the tide turned. Covid-driven stocks picked themselves back up and “reopening” stocks stalled out.
So today we’ll sift through the first earnings reports to get a little insight into where the market stands. I’ll also touch on investors’ weird response to earnings—which hints at the expectations baked into today’s record valuations.
Let’s dig in.
A very “surprising” earnings season
Wall Street analysts have a way of overshooting. But this time, even Wall Street underestimated what so far has been the most “surprising” earnings season on record.
As I write this, 1 in 3 American companies have reported their earnings. All together, they have grown their earnings by a strong 55% compared to a year ago. For some perspective, that’s almost double what the analysts expected.
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And by JPMorgan’s calculations, the S&P 500 companies are already making more money than they did before Covid was a thing:
So far, “reopening” sectors—financials, materials, and consumer discretionary—are picking up most of the slack.
Seeing this, you can’t help leaping to the conclusion that the Covid trade is over and the recovery is here. But if you peek under the hood, the picture becomes more nuanced. It reveals a transition that’s still shrouded in a lot of unknowns.
Transitioning from a Covid economy to a reopening economy
From the data and reports I’ve skimmed so far, here’s a rapidfire rundown of trends I noticed.
Trend #1: Tech is still growing at breakneck speed on the inertia of Covid’s way of life. But investors worry that growth may soon fall off the cliff, either because a) their guidance points to a slowdown in the future, or b) common sense says this can’t go on when life gets back to normal.
Take Netflix as an example. The company reported a record number of subscribers and a 300% jump in profits compared to last year. But the stock plunged 10% on the news. Why? Because Netflix is no longer pulling in as many subscribers as before. And the company warns that the growth will likely stall next quarter.
Trend #2: Banks are killing it. In terms of rising profits, they are the #1 reopening industry so far. But most of their profits have nothing to do with reopening. They are coming from released “reserves”—which is the money banks had set aside for loan losses that didn’t come to pass. That’s a one-timer.
Another of the biggest source of earnings is investment banking and trading, which is more a result of Covid, not recovery. Meanwhile, their core business of lending is barely picking up.
Trend #3: Covid-driven shortages are another big driver of earnings. Among other things, Covid has disrupted the supply of raw materials. And now the supply can’t keep up with exploding demand from construction and homebuilding. The result: commodity prices are blowing up and certain sectors like materials are cashing in big time.
How much of that is a result of Covid or of a reviving economy is up for discussion.
Trend #4: Airlines (one of the purest “reopening” industries) bleed. While demand for air travel is looking up and some airlines expect to break even next quarter, their profitability is still far off pre-Covid times. For example, United Airlines expects to reach its pre-Covid profitability only in 2023.
Trend #5: The consumer discretionary sector (another “reopening” sector) is still growing on the back of Covid. Restaurants and hotels are bleeding. Meanwhile, the sector’s biggest winners cater to the Covid way of life—e.g. businesses built on e-commerce and fast food chains driven by takeouts, etc.
Chipotle is a good example. Its earnings are booming because it has nailed online ordering. Pick up orders now make up more than half its sales. Good for Niccol—well, as long as there are few other options. But what will happen when more restaurants open up and people fed up with fast food have choice?
I guess even Chipotle executives are stumped. The company refused to give an outlook for the rest of the year due to the “ongoing uncertainty surrounding the future impact of COVID-19.”
In other words, the stock market is at a crossroads. Covid and its side effects on people’s lives and the economy are still driving a good chunk of earnings. But the longevity of this growth driver is in doubt. Meanwhile, reopening stocks are running a little ahead of themselves.
Maybe that’s the reason investors don’t give a damn about great earnings?
The market is ignoring great earnings
Textbooks and, well, common sense suggest that such strong earnings must be great stocks. Historically, that’s how the market used to work. But that pattern recently broke.
Take a look at this chart that shows the performance of stocks beating and missing earnings this season:
For the most part, Mr. Market punished stocks no matter what they showed for the last quarter. And there are three potential reasons investors have turned so unappreciative lately:
- The unknown of the transition makes investors more skittish
- The stock market is counting more on loose policy and stimulus
- The market is pricing in higher hopes for the rest of the year when the economy actually reopens
For those reasons, don’t get too hung up on this earnings season. The record stock valuations are pricing much more than this season can deliver. And all eyes are on the rest of the year.
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