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Earnings say we're early cycle

Myles Udland
·Anchor
·3 min read
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Wednesday, February 10, 2021

A version of this article first appeared in the Morning Brief. Get the Morning Brief sent directly to your inbox every Monday to Friday by 6:30 a.m. ET. Subscribe

People keep calling bubbles, but this cycle is just getting started.

Fourth quarter earnings season is rolling along and results to date have been fantastic.

As Sam Ro chronicled in Monday’s Morning Brief, through last week 81% of companies in the S&P 500 that had reported earnings so far beat expectations by an average of 15.2%.

At the end of 2020, we argued in this space that what had in part gotten investors enthusiastic about stocks last year was the anticipation of corporate results rebounding more quickly than feared. And indeed these results continue to confirm what the market has been out in front of for some time now.

Fourth quarter earnings results are currently tracking to a 1.7% year-over-year increase. In other words, corporate profits are on pace to exceed pre-pandemic highs even before additional stimulus, wider distribution of vaccines, and a more robust economic re-opening even take hold.

And while the rally in the overall markets alongside more speculative activity in heavily shorted stocks or some cryptocurrencies like Dogecoin (DOGE-USD) might have some investors nervous, this return to earnings growth is textbook early cycle behavior.

In his latest note to clients published Tuesday, Keith Lerner, chief market strategist at Truist Advisory Services, highlighted the following chart showing the present rebound in earnings tracking right alongside what we saw coming out of the financial crisis.

Earnings crashed in 2020 as the pandemic brought the economy to a stop, but the huge rebound in profits expected this year and next make the market look a lot like it did coming out of the financial crisis. (Source: Truist SunTrust Advisory Services)
Earnings crashed in 2020 as the pandemic brought the economy to a stop, but the huge rebound in profits expected this year and next make the market look a lot like it did coming out of the financial crisis. (Source: Truist SunTrust Advisory Services)

“Indeed, the earnings power of corporate America remains under-appreciated,” Lerner writes.

“This is aligned with the view that we laid out last summer that surviving companies were set to come out on the other side of this crisis more efficient and profitable than ever, aided by the acceleration of technology and productivity trends.”

Readers of the Morning Brief will be familiar with this idea from our prior work on operating leverage and how this force can boost corporate bottom lines as we return to economic growth.

We’d also note that holding a constructive view on the market does not mean Lerner or anyone else with this position is blind to elevated valuations, which are almost uniformly high relative to history. Though as Lerner notes, we haven’t exactly seen valuations rise over the last six months as earnings expectations have outpaced the market’s gains.

A common talking point in markets has been how expensive stocks are relative to history. And while valuations are elevated, a huge rebound in earnings expectations has outpaced gains in the S&P 500, keeping valuations relatively stable for six months now. (Source: Truist SunTrust Advisory Services)
A common talking point in markets has been how expensive stocks are relative to history. And while valuations are elevated, a huge rebound in earnings expectations has outpaced gains in the S&P 500, keeping valuations relatively stable for six months now. (Source: Truist SunTrust Advisory Services)

“The market is not cheap on an absolute basis; however, it also does not appear to be in a bubble either,” Lerner adds.

“Our work shows that it is typical for stocks to see positive returns but a notable moderation of gains after the initial snapback from a bear market low. In the current phase of the bull market, we continue to expect the driver of equity gains to be an earnings recovery.”

By Myles Udland, a reporter and anchor for Yahoo Finance Live. Follow him at @MylesUdland

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