With the start of a new year, many are looking forward to brighter days ahead. Investors appear to share this hope, with S&P 500 earnings expected to grow 23 percent in 2021 after declining 14 percent in 2020. As of early March, over 90 percent of S&P 500 companies have reported earnings for the fourth quarter of 2020. In a continuation of the recent trend, earnings have come in stronger than expected, with sales reported about 3 percent higher than initial expectations and earnings a solid 18 percent ahead of analyst predictions. In aggregate, analysts appear to have been too dire in their forecasts for the final quarter of 2020.

Post-earnings trading

One area in which the fourth quarter earnings season has differed from recent trends is in post-earnings trading activity. In the most recent quarter, companies that reported better than expected earnings have generally traded flat or down on positive reports, rather than increasing in price. In contrast, stocks of companies reporting weaker than expected earnings are not declining as much as they have in the past, on average. One of the more pronounced examples of this trading action can be observed in the technology sector where average earnings came in nearly 17 percent better than expectations. Despite the strong earnings, these tech stocks traded down an average of 1.6 percent the day following the report.

We believe the difference in trading action this quarter may be related to a recent change in market leadership which started in November with the announcement of Pfizer’s vaccine approval. During this shift, market participants have witnessed the outperformance of stocks with cyclical business models as well as those companies which should benefit from a resumption of more normal economic and consumer activity. This change in market leadership has also aligned with the recent outperformance of Value stocks over Growth stocks, as well as small- and mid-cap stocks outperforming their larger cap counterparts.

Return to normal, consumer demand for housing, strong demand for semiconductors

In reviewing management commentary from the most recent earnings season, we have observed several themes. First, companies are anticipating a return to more normal activities starting as soon as the second quarter of 2021. As COVID vaccines are administered, people may begin to travel, eat at restaurants, and socialize again. However, some companies believe that consumer behavior has been permanently changed by COVID, particularly in relation to e-commerce. Many companies continue to invest in technology to support these changes, viewing technology investment as imperative to the future success of their business.

Another area of strong consumer demand relates to housing. Housing-related companies, including homebuilders, building products manufacturers and retailers, have commented on the continued strength of consumer demand for products to improve existing living spaces, or for new homes altogether. Demand for new and existing homes has been strong, and supply has been constrained, leading to home prices increasing rapidly. In fact, the Case-Shiller Home Price Index, a widely watched national gauge of home prices, increased 10 percent year over year for the December month-end. Other measures which incorporate more real-time data have shown an acceleration from this already strong level. We will be watching closely for any changes in this area in case interest rates move higher since a higher cost of borrowing may slow activity in this space.

We are also noticing strong demand trends in the semiconductor industry. Supply chain constraints are a gating factor across many industries due to shortages in key input materials including chips. Increasingly, semiconductors are used in the production of everything from smartphones to autos to appliances. Due in part to supply constraints relating to COVID, as well as the increased demand for semiconductors in many types of products, these bottlenecks are causing delays in production and delivery of finished goods. These shortages may lead to inflationary pressures, which some companies are able to pass along to the end consumer. Inflation is another area where we remain vigilant and are watching for signs of higher prices in the near- and intermediate-term as well as for indications of which companies can pass along rising input costs.

Strong health care sector

Finally, activity in the health care sector continues to be vibrant. Many companies invested heavily during 2020 to support the development of COVID-19 treatments and have reported billions of dollars in additional COVID-related revenues. For many companies, these massive investments should remain beneficial even after COVID-related activities have subsided with additional applications of new health care technologies and infrastructure.

Final quarter of 2020 better than feared

In aggregate, corporate earnings have come in better than feared for the final quarter of 2020. We remain hopeful that as vaccines continue to be administered, the areas of our economy most significantly impacted may begin to recover. Some segments of the economy continue to experience solid fundamentals—including technology and home-related retailing—but with a resumption of more normal activities, other depressed areas such as travel and cyclical industries should see stronger trends. We will be watching for evidence of this improvement in the coming months.

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Published on March 10, 2021