Earnings (or profits) are a key driver of share market returns. US earnings are particularly important as they represent more than half the earnings of global share markets. This article briefly looks at recent developments in US earnings with a focus on the S&P 500 index, which represents the largest 500 US listed companies.
In March 2020, global share markets fell very sharply as fears related to COVID-19 caused investors to rapidly revise down their expectations for earnings in 2020 and the outlook was more uncertain. Since late March, most share markets have increased materially and, in some cases, achieved new highs – despite most economies operating well below their pre-COVID capacity.
The US S&P 500 is one of the share markets that hit new all-time highs in December 2020. While there are several factors, earnings outcomes have played an important role. While earnings growth was very weak in the second quarter (April through June or Q2 2020), it was much stronger than the outcome expected by consensus at the start of that quarter. A similar pattern was observed for Q3 2020 earnings. The upward surprises (versus consensus expectations) for these two quarters were among the strongest in history, which helped push the S&P 500 higher. It appears that policies such as increased government spending and low interest rates have helped underpin better than expected earnings.
As at 4 December 2020, 99% of S&P 500 companies had reported Q3 earnings. The chart below shows that Q3 earnings was stronger than consensus expectations in each of the 11 industries, with the S&P 500 surprising by 19.7% versus an historic average of around 5%. Some of the cyclical industries had the greatest upward surprise (eg Consumer Discretionary and Industrials).
S&P 500 Sector - Level Earnings Surprise % - Q3 2020
Source: FactSet: Earnings Insight, 4 December 2020
While the Q4 2020 earnings season is just commencing, earnings for this quarter have been revised up during the quarter so far, which is the opposite of what typically happens. This has helped to boost the S&P 500 despite a large increase in COVID-19 cases in the US over the past two months.christmas
Along with earnings revisions, recent developments in relation to a vaccine have also been very supportive for share markets. Vaccines are likely to allow higher levels of earnings over the medium-term. While the price to earnings valuation for the US S&P 500 is high versus historic averages, low interest rates and policy stimulus are helping to support current levels. Low inflation is allowing policy to remain stimulatory. Looking forward, US earnings outcomes are likely to be an important driver of global share market returns. Consensus is currently expecting strong US earnings growth of around 20% in 2021.