As we get into the heart of the earnings season, we thought we’d take a final look at earnings estimates. The chart below shows that S&P 500 estimates have been rising in uninterrupted fashion since mid-2020. In fact, the consensus estimates for 2021 and 2022 have each risen about 9% since that trough. The upward revisions obviously reflect the success of the vaccination efforts, the massive amount of fiscal stimulus enacted to date (and the promise of perhaps trillions more), and the Fed’s determination to maintain maximum policy accommodation at least until a large percentage of the population has been inoculated. These factors have led economists to increase projections for economic growth, with the Federal Reserve and International Monetary Fund each expecting US GDP to expand at an inflation-adjusted 6.4%-6.5% in 2021. It’s quite possible that growth could come in even higher than that.
The upward revisions in earnings estimates have been a potent factor to offset concerns about rising inflation, interest rates and taxes. A key question will be how much power businesses will have to pass on rising input costs, including labor, to their customers. If they are successful in fully offsetting cost pressures, the sting from moderately higher inflation may be minimal. If, however, they are unable to pass on any of the cost increases for competitive reasons, corporate profit margins could come in well below elevated expectations and earnings estimates could be revised sharply lower. The answer probably lies somewhere in between, as consumer spending power, boosted by a rapidly improving labor market and record savings rates, may be somewhat offset by a heavy concentration of wealth and income at the upper end.
We raise this issue again because it is an important one: The current estimates for S&P 500 earnings in the years 2021-2023 appear to completely disconnect from the trendline in GDP, as projected by the Federal Reserve and others. We wonder if it will be possible for corporate earnings to grow that much faster than the economy at large. The current estimates, as shown in the chart below, would result in corporate earnings growing at an annual growth rate of 17% over the next three years compared to just 6% for the economy at large. If these estimates are indeed correct, it would mean that owners of capital will continue to enjoy the lion’s share of the benefits of economic revitalization. Given the progressive nature of the Biden administration, that may not be a good assumption. From where I sit, it sure seems more likely that either earnings estimates come down or GDP growth is revised higher.
Stay the course. Stick with quality and reasonable valuations.