On the Radar

City National Rochdale, | Apr. 12, 2021

FAQs on the Markets and Economy

What is the outlook for Q1 earnings?

First quarter earnings season begins this week, and expectations are running high for a strong follow-up to the fourth quarter's much-better-than-expected-results. Consensus estimates for Q1 S&P 500 year-over-year earnings growth now stands at 24.5%, up 6% since April 1.

That’s the biggest increase in analyst projections since FactSet began tracking quarterly bottom-up earnings estimates in the second quarter of 2002. Normally, analyst estimates decline as the quarter progresses with the average decrease of the last five years at 4.2%.

Part of the strong growth in Q1 is reflective of easy comparisons, making results harder to interpret as the last month of Q1 2020 was weighed down by the onset of the pandemic. One key to watch for is whether or not more companies resume providing forward guidance after COVID-19 related suspensions.

Still, corporate America has done a tremendous job over the past year adapting to the pandemic, innovating, and generating efficiencies. Going forward, we expect earnings to get an additional boost from pent-up demand unleashed by the vaccine-driven reopening of the U.S. economy and a strengthening global outlook.

Given lofty valuations, this expected recovery in earnings will likely be key for stock prices to take the next step higher.

It probably helped. Consumer confidence in March surged 12.8 points to 109.7. In addition to the money, there has been good news on the vaccinations, reopening of the economy, and pleasant spring weather following a horrific February.

One of the important subcomponents of this Confidence Report is the outlook for labor. It usually takes years for the “jobs plentiful” category to have a higher reading than “jobs hard to get” following a recession. But now, jobs plentiful is 7 points higher than jobs hard to get (chart).

The jump in confidence, we believe, is a preview of a massive spending spree. Households hadn’t entirely spent their January $600 check, and now they just got a $1,400 check, and they have built up savings from last year. When you combine all that money with a buoyant mood, strong spending should follow.

The recent labor report was unambiguously strong. The March increase, along with revisions, puts the net gain in nonfarm payrolls over 1 million. There were significant job gains in the leisure and hospitality sector, where employers hired 280,000 workers. The reopening of the economy has created job opportunities at hotels, airports, concert venues, sports stadiums, and retail stores.

So far, there has been the creation of 13.9 million of the 22.4 million jobs lost since last spring, representing a 63% recovery (chart). There is still a lot of ground to make up; 8.4 million Americans remain unemployed from last year’s peak.

What is most exciting about this report is the growth prospects for the next few months. Payroll growth is expected to be strong amid lower COVID-19 cases, continued relaxation of business constraints in many states, a growing number of Americans that are receiving vaccinations, and a household full of cash.

Surprisingly, it is stronger than previously expected, some may even call it explosive. The ISM manufacturing index surged to 64.7 in March, the highest reading since 1983 (chart). There were substantial increases in all the major categories.

The outlook is also great. The sub-category of new orders is at the highest level since 2004, and order on backlogs is at the highest level on record, dating back to 1993. There are also record low inventory levels. The pipeline is strong.

There are supply challenges. The sub-category of supplier deliveries reached the highest levels since 1974 (oil embargo days). It has been extending through the pandemic due to social distancing rules, which have reduced production, but the recent increase might be due to the well-publicized chip shortage.

Factories are having a difficult time keeping up with demand. They should continue to be strong part of the economy for some time.

President Biden’s “American Jobs Plan” proposes $2.3 trillion in new spending over eight years on infrastructure, manufacturing, research and development, and clean energy, among other things. This is likely the first of a two-part recovery package that could approach $4 trillion, with the second part focusing on social spending and welfare.

To pay for the infrastructure package, the administration is proposing a number of corporate taxes to offset the cost of spending programs over 15 years, including the unwinding of the 2017 cut in the corporate tax rate to 21% from 28%. The second part of the package will likely include tax increases on high-earning individuals.

Unlike the recently passed American Rescue Plan, the American Jobs Plan is expected to take months to pass and see far more significant revisions as the negotiation process plays out. Early responses from congressional lawmakers have been as predicted, with Republicans objecting to any tax increases and progressives saying the plan is not bold enough.

Ultimately, we expect Democrats will find a way to pass significant infrastructure and green energy spending while raising at least some taxes to pay for it, including a compromise increase on the corporate tax rate to around 25%.

The potential for tax hikes could be a source of volatility for stock prices in the months ahead, and investors should also begin reviewing their tax budgets with an eye on changes to come.

Still, markets have so far taken the president’s initial proposal in stride, and given our expectation for a durable economic recovery, we do not expect any future bill will undermine the bull market. While an increase in corporate taxes would trim next year’s earnings somewhat, prospects for corporate profitability remain robust and the drag could potentially be offset by a boost to growth from higher fiscal spending.

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