Corporate earnings are increasing again, reflecting that the U.S. economy is more than on track for recovery.
Companies representing roughly three quarters of theS&P 500’smarket capitalization have reported fourth-quarter earnings, according to Credit Suisse data. Combining actual results and analyst’s increases to their calls for profits of companies that haven’t yet reported, aggregate earnings per share for the index could rise 1.7% year over year, according to DataTrek.
So far, the aggregate result is about 17% better than expected, Credit Suisse says. Sales are up about 1% and operating margins have expanded, creating the much improved bottom-line results.
Two points in the earnings results indicate an improving economy.
Credit Suisse flagged the higher sales as a sign that consumers and businesses are spending more. Sales are up 4% year over year at makers of apparel and durable goods, according to the bank.
Changes in profit margins tell a more important story, underscoring how a healthier economy is improving the earnings of the companies that were hurt most by the pandemic. A high portion of the costs of oil producers and manufacturers are fixed, so when revenues fall during a recession, profits fall harder than at other companies.
Coming out of recessions, when revenues improve, profits rise significantly because costs are stable. Sales of materials producers are up 2% in aggregate, but earnings are up 17% because operating margins have increased by 14 percentage points.
Stocks across many sectors have indeed risen, but earnings have not been the primary driver behind the breadth of the rally. TheInvesco S&P 500 Equal Weight ETF(RSP), which weights each holding equally and reflects the degree to which all sectors are participating in the rally, is up more than 4.5% year to date. That beats the gain in the popular S&P 500 index, which is weighted according to market capitalization—a sign the rally has been inclusive of many sectors. That is a reflection of a strengthening economy.
Earlier in the profit-reporting season,most stocks were falling, with losses of 1% or more, even after companies reported strong earnings.Valuationswere high, reflecting expectations for strong results, so the actual results failed to provide much of a jolt.
In any case, strength in earnings won’t matter if the rollout of Covid-19 vaccines encounters big delays, because that would hurt the outlook for revenues. Stocks are trading more in response to positive vaccine news than on the fourth-quarter results.
The earnings still do matter, though. And if therollout of vaccinesdoesn’t run into new snags, EPS should rise quarter over quarter throughout the year.
Wall Street expects about $42 in aggregate per-share earnings for the S&P 500 for the fourth quarter of 2020, while estimates for the current quarter are a tick below that, according to DataTrek. If earnings come in at $45 a share per quarter for 2021, the year’s result should be $180, about 2.8% higher than current estimates.