Monday, March 29, 2021

High-Octane Earnings

I am raising my S&P 500 operating earnings forecast for 2021 from $175 per share to $180, a 27.8% y/y increase from 2020. I am also raising my 2022 forecast from $190 to $200, an 11% increase over my new earnings target for this year. I would have raised my 2022 estimate more but for my expectation that the Biden administration will raise the corporate tax rate next year.

As I've observed, the economy was hot before the third round of “relief” checks started going out around mid-March. Now it is likely to turn red hot as the Treasury sends $1,400 checks or deposits to 285 million Americans in coming weeks.

I have also observed that the average of the business activity indexes compiled by the Federal Reserve Banks (FRBs) of New York and Philadelphia for their districts jumped from 17.6 during February to 34.6 during March, the highest reading since July 2004 (Fig. 1). This is a very significant development for the following reasons:

(1) Regional and national business surveys. Their average tends to be a good leading indicator for the average of the five surveys conducted by these two FRBs along with the ones in Richmond, Kansas City, and Dallas. The average of the five business activities indexes is highly correlated with the national M-PMI (Fig. 2). That means that the average of the New York and Philly indexes also is highly correlated with the national M-PMI and is signaling a solid number for the latter’s March reading (Fig. 3).

(2) Business indexes and S&P 500 revenues growth. “What does this have to do with S&P 500 earnings?,” you might be wondering. Good question. I won’t keep you in suspense. Previously, I’ve observed that the M-PMI is highly correlated with the y/y growth rate in S&P 500 aggregate revenues (Fig. 4). February’s M-PMI reading of 60.8 matches some of the best readings in this indicator since 2004! The March reading could be stronger, implying that S&P 500 revenues may be set to grow 10%-15% this year. That’s certainly confirmed by the similar relationship between the growth in revenues and the average of the New York and Philly business activity indexes (Fig. 5).

(3) Profit margin. That strong outlook for revenues growth provides a very good tailwind for earnings growth, which will also get a lift from a rising profit margin. I think that the profit margin, which averaged 10.4% last year, could increase both this year and next year. Profit margins tend to rebound after recessions and during recoveries along with productivity.

(4) Bottom line on the bottom line. Let’s put it all together now. I am raising my S&P 500 revenues forecast by $50 to $1,550 per share this year, up 14.0% from the 2020 level (Fig. 6). For next year, I am sticking with my $1,600 revenues estimate, representing just a 3.2% increase. That’s because I believe that the relief checks, besides relieving pent-up demand, will pull forward some of next year’s demand. Also, individual tax rates are likely to go up next year along with corporate ones.

I am projecting that the S&P 500 profit margin will increase from 10.4% last year to 11.6% this year and 12.5% next year (Fig. 7). The result would be S&P 500 earnings of $180 per share this year and $200 next year (Fig. 8). (See YRI S&P 500 Earnings Forecast.)

Analysts Bullish on S&P 500 Fundamentals

I am not the only one turning even more bullish on the fundamentals driving the stock market. Industry analysts also are raising their estimates for revenues, earnings, and profit margins for the S&P 500 for this year and next year. Consider the following:

(1) Quarterly consensus earnings estimates for 2021. The analysts’ consensus estimates for quarterly S&P 500 earnings per share this year have been rising since mid-2020 (Fig. 9). As of the March 18 week, they were projecting the following y/y growth rates for S&P 500 operating earnings: Q1 (20.0%), Q2, (50.1), Q3 (18.0), and Q4 (12.5) (Fig. 10).

(2) Annual consensus earnings estimates for 2021 and 2022. As of the March 18 week, the consensus predicted that S&P 500 earnings per share will be $175.54 this year and $202.11 next year (Fig. 11). Currently, industry analysts are expecting that S&P 500 earnings will increase 25.5% this year compared to last year (Fig. 12). For 2022, they are anticipating a 15.2% growth rate.

(3) Annual consensus revenues and margin estimates for 2021 and 2022. Industry analysts are currently projecting that revenues will total $1,459.08 this year and $1,558.19 next year (Fig. 13). In other words, they are expecting revenues per share to grow 9.4% in 2021 and 6.8% during 2022 (Fig. 14).

Interestingly, their estimate for 2021 revenues growth has been increasing since the week of November 19, undoubtedly reflecting expectations that President Biden’s American Rescue Plan would be enacted early this year and be very stimulative, adding roughly two percentage points to revenues growth. The expected growth rate for 2022 hasn’t changed much since late last year.

I calculate the implied profit margins from the consensus estimates for earnings and revenues. The results show that margin estimates have been improving since last summer for 2020, 2021, and 2022. The latest readings for these in 2021 and 2022 are 11.8% and 12.7% (Fig. 15).

(4) Forward ho! Both S&P 500 forward revenues and forward earnings have now fully recovered what they lost during the first few months of the pandemic (Fig. 16). Both took much longer to recover during the Great Financial Crisis. The same can be said for the forward profit margin. The weekly forward revenues, earnings, and profit margin series are all excellent coincident indicators of the comparable actual comparable data (Fig. 17). All three of the weekly series remain bullish on the underlying fundamentals for the S&P 500.

I am raising my year-end 2021 and 2022 forward earnings forecasts by $5 each to $200 and $210 (Fig. 18). Think of these as my best guess of what industry analysts will be projecting earnings will be in 2022 and 2023 at the end of 2021 and 2022. (See our 2020 study titled S&P 500 Earnings, Valuation, & the Pandemic for a thorough explanation of forward earnings.)

(5) S&P 500 targets and valuation. Even though I am raising my forward earnings targets, I am keeping my S&P 500 stock price targets at 4300 and 4800 by the end of this year and next year. That buys me a bit more wiggle room on our valuation multiple assumptions, which are now 21.5 and 22.9 for the end of this year and next year (Fig. 19). The multiple is currently 21.6.

One of my accounts asked me whether I should lower my outlook for the forward P/E given that I am predicting that the 10-year US Treasury bond yield is likely to rise back to its pre-pandemic range of 2.00%-3.00% over the next 12-18 months.

Normally in the past, I would have lowered my estimates for forward P/Es in a rising-yield environment. However, these are not normal times. In the “New Abnormal,” valuation multiples are likely to remain elevated around current elevated levels because fiscal and monetary policies continue to flood the financial

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