Corporate Profit Update
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The strong recovery of corporate profits has ignited optimism on Wall Street that the U.S. stock market will continue the bull market, although investors question whether companies can surpass the high thresholds for profit growth and profit margins.
The latest quarterly report shows that since FactSet began tracking these indicators in 2008, US corporate earnings, revenue and profit margins have grown at the strongest rate.
This performance has helped push the U.S. stock market to new highs, and the S&P 500 index has risen by more than 18% so far this year. The index has doubled from its low in March 2020, when the pandemic blockade plunged global financial markets into chaos.
Russ Koesterich, portfolio manager of BlackRock’s Global Allocation Fund, said: “Economic growth is running at the best rate we have seen in decades, and this is a huge tailwind for profitability.”
Due to the upward adjustment in earnings growth, analysts at Goldman Sachs and Credit Suisse have recently raised their 12-month forecasts for the Standard & Poor’s 500 Index. FactSet data shows that Wall Street analysts set the target price of the Standard & Poor’s 500 Index at 4,949 points in 12 months, which is expected to rise by 11%.
“We have always been optimistic about [on] Increase holdings of global stocks for a period of time. ..[but]We are surprised by the strong performance of earnings, so we need to reflect this,” said Sharon Bell, equity strategist at Goldman Sachs.
For investors, this story seems more challenging because the stock market has already reflected a lot of optimism, and overall valuations are still at historical highs.
“For Standard & Poor’s, this is a truly spectacular quarter. The question is where will you go?” said David Kelly, chief global strategist at JP Morgan Asset Management. “It will be difficult for companies to maintain high water levels, and compared with other parts of the world, valuations in the United States are still expensive.”
At the beginning of this year, the trading price of the S&P 500 Index was 22.7 times the expected profit for the next 12 months. Since earnings growth has exceeded the market’s gains, this indicator has slowed to 21.1 times, but it is still higher than the average of 18.1 times in the past five years.
“This year’s multiples are generally flat, and the market is moving higher due to strong earnings growth,” Koesterich said.
Tim Murray, capital markets strategist of T Rowe Price’s multi-asset team, said that the pace of expected earnings growth must be balanced with the rise in US stock valuations. “This means that when earnings exceed expectations, there is less upside, and disappointing results in the future will bring more downside.”
Although the overall valuation of the market is not “cheap”, Koesterich said that many large companies that generate cash flow are registered in the United States and will maintain “healthy revenue growth” as the economy grows faster than the trend-more than 2%. . Entering next year, interest rates remain low.
“Historic” earnings season
After the coronavirus crisis severely depressed profits in the same period last year, US corporate profits soared in the second quarter of 2021.
FactSet’s data shows that taking into account the results of the report and the estimate of 10% of companies that have not disclosed data, the profits of companies listed on the US blue chip S&P 500 index have jumped by about 90%. At the same time, sales soared by about a quarter.
These numbers are far better than Wall Street’s predictions before the start of the earnings season. At the end of March, analysts expected profit growth of 53% and revenue growth of 16%.
Kasper Elmgreen, head of stock at Amundi, said: “In terms of deliverables, the earnings season has historical significance.”
Investors are also paying attention to the profit margins of the S&P 500 index constituent companies. This indicator rose to a record 13% in the second quarter, up from 12.8% in the previous quarter. This is the result since FactSet started tracking the indicator in 2008. The highest level.
Koesterich said that in the second quarter “margins remained unchanged”, he warned that margin pressures in the next few quarters-companies cannot pass on rising input costs such as wages-will be a test of stocks and high valuations. .
“Wage inflation does not happen overnight,” Kelly said. The Fed’s efforts to reduce unemployment “will trigger higher wages and put pressure on corporate profits.”
Another disadvantage for American corporate profits is that companies under the Biden administration may pay higher taxes.
Earnings “may have peaked… As the market begins to price these higher taxes, we will see them slow in the coming months,” said Lale Akoner, senior market strategist at New York Mellon Investment Management. “I expect that sometime between October and December, the market will start pricing it.”