This past week kicked off the US and global first quarter 2021 earnings season. This coming week another 81 companies from the US S&P 500 will report their first quarter results. Relative to historic norms, more companies are beating analyst expectations on revenues and profits than on average. Accordingly, analyst expectations for earnings have risen to their highest levels for any quarter since 2010.
Specifically, with just under 10% of companies having reported thus far, over 80% have recorded ‘beats’, which is roughly five percentage points above the long-term average. Revenues are also running well ahead of historic average ‘beat’ rates. At their current pace, S&P 500 year-on-year earnings could rise over 30% for Q1 2021.
To be sure, the earnings season is just under way and the data, so far, is skewed by the early reporters, above all financials. The coming weeks will see more heterogeneity of company releases, including some sectors such as Industrials that may lag their peers.
Earnings weren’t the only factor driving equity markets last week—falling bond yields also helped. That’s why utilities, information technology and quality stocks such as healthcare or consumer staples, which typically benefit when long-term interest rates dip, joined more cyclical sectors such as basic materials or consumer discretionary in leading major equity indices to new all-time highs.
Yet the latest drop in bond yields appears anomalous on the basis of very strong retails sales, production, employment and GDP data from the US and China. US economic re-opening, buttressed by rising vaccination rates, is likely to spur spending and growth in the coming quarters, reinforced by powerful fiscal stimulus and ongoing monetary policy support.
Accordingly, rotation trades into more cyclical and value-oriented styles and sectors appear to have legs.
From that perspective, it is worth pondering the prospects for regional rotation.
Regional performance is even more interesting given that non-US markets generally enjoy better earnings prospects in 2021 and lower valuations. Yet they have not yet convincingly delivered, even though rotation has begun in sector and style terms.
To begin, consider first quarter earnings estimates. As of early April, company analysts were forecasting strong earnings growth across all global markets. Most attention, unsurprisingly, has been focused on the US, where economic re-opening and fiscal policy stimulus are expected to boost Q1 2021 S&P 500 earnings by 24%. Yet as impressive as that figure may be, it is broadly matched in bottom-up analyst estimates by Europe and Japan and dwarfed by a 35% increase forecast for emerging markets, led by Latin America. Top of the list is the United Kingdom, where first quarter earnings are forecast to rise by 46%.
Yet global equity market performance, year-to-date, has been patchy as regards global rotation. Canada, the UK and the US have led the way, with strong gains by the (now faltering) Energy sector in the first months of the year. Japan has lagged badly, and emerging markets have struggled to even post positive results for the year.
That’s also curious given relative valuations. In absolute terms, the US equity market trades at a premium price-to-earnings ratio relative to the world average. This makes sense, given the dominance of growth sectors in the US market, as well as a strong showing from ‘quality’ stocks, ones that have dependable earnings and robust balance sheets.
Over the course of this year, however, that valuation gap has grown, as the US premium has inched higher, whereas other markets have de-rated in relative and even in a few cases in absolute terms. Rotation may be catching investor attention in stock or sector terms, but it has not yet fully translated in regional terms.
Above all, Latin America and the UK have experienced the biggest relative de-rating this year, and indeed over the past five years. As a group, Latin American equities trade at nearly a 40% valuation discount to the world average. The UK has de-rated to a 25% discount to global equities.
A mix of factors may partly explain these anomalies. The global pandemic has hit Brazil and India particularly hard. Brexit dislocations continue to hamper the British economy and are a convenient rationale for investors to shun the market. After a strong run, oil and commodity prices have topped out, leading to some investor re-assessment of Energy and Basic Materials stocks that account for larger fractions of UK and emerging indices. Finally, for all the steps the Biden Administration has taken to unwind Trump policies, US policy towards trade—in particular trade with China—has remained ambivalent at best. Global trading economies and markets, including those of Europe, the UK, Japan and emerging countries would benefit from a relaxation of tariffs and trade tensions.
Still, a rising tide offered by stronger growth prospects in the world’s two largest economies—the US and China—should lift many boats. Forward-looking markets should anticipate that today’s consumption booms will boost production along supply chains, increasing the demand for raw materials, industrial goods and financial services across the globe.
Absent a resurgent pandemic that defies vaccination or a shift in global monetary policy, the stage is set for rising global output and corporate earnings for the remainder of 2021. Analyst estimates are broadly correct that the biggest beneficiaries will be beaten up cyclical and value sectors, found more prominently in emerging economies and in Europe and Japan’s industrial sectors. Rotation, which has arrived in sector terms, is coming to a country near you.
