Over the past week, equity markets moved higher, and interest rates continued to moderate. First quarter earnings will now be a large focus for investors in the next days and weeks. Banks kicked things off last Wednesday and reported big numbers. Goldman Sachs, JPMorgan Chase and Wells Fargo all beat estimates. As mentioned previously, FactSet is projecting earnings growth of 24.5% overall for Q1 2021. If that comes to pass it would be the best quarter for earnings since Q3 of 2018.
Let us remember a few key concepts here. The first is that earnings growth is a big part of what drives equity prices, and indirectly drives allocation of capital to everything else. Simply put, earnings growth is key to the foundation of the all-consuming desire to chase return relative to risk. The second thing to remember is that equity markets (and bond markets) are forward looking. The earnings we are seeing now were previewed way back in the fall of last year. At that time, we saw outperformance of the equal weight S&P 500 compared to the market cap weighted index, rising bond yields, and the later rotation out of technology into other sectors of the economy. These were all clues that we looked for and discussed six months ago. (Some examples of this can be found in our commentaries from August 31, October 5 and November 23.) The change in political administration, and the prospect of additional stimulus was just icing on the cake. All of these things and more (like a Covid vaccine) resulted in the huge rally in stock and bond yields that started on November 1, 2020. Looking back six months, this new bull market seems obvious. It was all right in front of us.
So, with this refresher in mind, the question becomes, how much of this rally is already priced into the cake? It’s funny how that one question is always the question. It is the question whether markets are moving up or down. It is what makes investing an art as well as a science.
Right now, signs point to a growing cake and the possibility of more earnings growth ahead. There is no sure thing in this world, and anything is possible, but for today, equity prices appear poised to move higher. It surely will not be a straight line up – it never is. There will be pullbacks and roadblocks along the way. Fear not, as that is how it works… and work it is.