Seeing is Believing | Market Insights
- Earnings season is ramping up
- Some concerning signs may lead to short term volatility
- Are we starting to turn the corner on the latest COVID surge?
Almost a full month into 2021, markets continue to chug along without a worry in the world. This week marks the busiest week for 4Q 2020 earnings, with 33% of S&P 500 companies set to report. According to FactSet, the estimated decline in earnings on a year-over-year basis was -9.2% as of December 31st. There have already been some positive surprises which has cut the currently reported number to a decline of -4.7%. If this number were to hold, it would be the fourth straight quarter in which the index has reported a year-over-year decline in earnings. As important as the actual numbers are, investors will be paying close attention to the guidance offered by company management in an attempt to gauge the possibility of future growth.
Another thing to focus on will be how companies are treated for beating/missing estimates. Normally, companies will be rewarded for beating estimates with a share price increase and punished for missing estimates with a share price decrease. However, that relationship has currently flipped and has added another oddity to this market.
The chart above shows the 1 day relative performance for stocks vs. the S&P 500 the day after they report their earnings. The blue line represents companies that beat their estimates while the orange line represents companies that missed their earnings. You will notice that for most of the time period represented on this chart, the relationship is as you would expect, good earnings get rewarded while bad earnings are punished. But going to the far left and far right, you notice the two periods of abnormality. The last time this relationship flipped and companies were being rewarded for missing earnings was all the way back in 2000, right before the beginning of the end for the tech bubble.
Why Do We Care?
Some may look at the chart above and draw the conclusion that we are in another tech bubble and the pin prick is just around the corner, but that is not necessarily the point we are trying to make. The more important takeaway is that this is just another anomaly in a market full of them. The number of outlier observations going on right now should give everyone pause. It doesn’t have to be the type of pause that requires you do to something drastic, but the type of pause that should be reflective and encourage investors to re-evaluate their risk tolerance and investment thesis over the coming months.
At HCM, this is an exercise we perform on a constant basis. Over the last few weeks, we have updated our investment outlook for the coming year with the belief that a combination of additional stimulus efforts, vaccine rollouts, and improving economic conditions will continue to provide a tailwind for the markets. However, we don’t think this will happen in a straight line. As mentioned previously, many short term market indicators are signaling overbought conditions along with highly speculative behavior coming from some retail investors. In the past, these readings have signaled a higher potential for short term volatility. Due to this observed risk, we recently took the opportunity to recognize some profits in our Advance and Defend portfolios while also making slight changes to our fixed income positions.
While things will remain somewhat uncertain over the short-term, we feel confident our intermediate term outlook is gaining support. The 4Q 2020 reporting period will most likely mark the end to the negative year-over-year declines, with estimates for earnings growth over the next 4 quarters at 18.1%, 47.8%, 15.3%, and 18.1% according to FactSet. Some may argue that the bulk of those positive results have been “pulled forward” with significant price increases but we don’t see that across all sectors. Some areas of the market still haven’t seen full recovery and we would expect strong earnings to aide in that recovery, particularly in Value, Small Cap and Emerging Markets.
In addition to earnings, we have seen our first real reduction in COVID statistics since the most recent spike that began in early October. Over the past week, we have seen significant reductions in both case counts and hospitalizations, along with many states beginning to lift lockdown restrictions. If these reductions continue, along with help from continued vaccine distribution, it should provide a significant tailwind to the economy.
Ultimately, the market has reached a point where it would be beneficial for it to take a little breather. Many of the current excesses need to be resolved and earnings season may be the perfect backdrop to allow for some profit taking. We would see this as a welcome sign and an opportunity to add equities through active rebalancing.
Weekly Focus – Think About It
“Experience is a hard teacher because she gives the test first, the lesson afterward.”
Performance last week for the four major asset classes were:
- U.S. Stocks – Russell 3000 (IWV) – Gain of 1.84%
- Developed Foreign Markets (EFA) – Gain of 1.01%
- Emerging Markets (EEM) – Gain of 2.72%
- Fixed Income (AGG) – Gain of 0.0%
(Note: performance is based on the change in price plus dividends)
Last Week’s Headlines
- Equities finished the week slightly off record highs, as investors continue to balance positive news with near-term challenges.
- Housing continues to remain strong as starts and permits are both on the rise.
- COVID-19 statistics showed an improvement in trends for the first time since late November as both cases and hospitalizations dropped.
Eye on the Week Ahead
- Earnings reports will continue and investors will be looking for clues on the pace economic activity
If you have questions about the recent market conditions, please contact a member of HCM’s Wealth Advisory Team:
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- The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general.
- Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.
- Past performance does not guarantee future results.
- You cannot invest directly in an index.
- Consult your financial professional before making any investment decisions.
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