When analyzing the markets, we usually try to step back from the everyday ‘noise’ and offer fundamental perspective. But there are times when the calendar is so packed with data that keeping track of the high frequency information flow becomes unavoidable.
This is one of those weeks. Over the next five days investors face a veritable tsunami of corporate earnings and economic data releases. The week’s data deluge will be difficult to digest, but it could prove decisive for the markets for a long time.
By way of brief review, the past week was an up and down one for markets, with support provided to global equities and other risk assets via strong corporate earnings and improving growth data, offset by concerns about a potential hike in the US capital gains tax rate.
The coming week may provide some clarification from the Biden Administration on proposed changes to US capital gains taxation. Yet, it is important to note that higher taxes will be challenged in Congress, given steadfast Republican opposition and differing views among Democrats. At this point, passage of a higher capital gains tax rate, even for the 0.3% of Americans who make more than $1 million per year, seems remote. That’s why markets bounced back on Friday.
And that sets the stage this week for corporate earnings reports from over a third of the top US companies and a trove of important global macroeconomic data releases. Specifically, 177 S&P500 companies will report earnings in the next five days, highlighted by the top six companies in the index. Information technology stalwarts Alphabet, Amazon, Apple, Facebook, Microsoft and Tesla lead the way. Bellwethers for household spending, such as Visa, Mastercard and McDonald’s, will also release their Q1 numbers this week. And, big industrial and energy players like Boeing and Chevron will likewise in the spotlight.
With over 25% of companies having reported first quarter earnings, ‘beats’ are running at about 84%, some ten percentage points above long-term averages. Revenues are exceeding consensus forecasts by a similar margin. Overall, first quarter earnings growth estimates have now risen to 33% year-on-year, up from a 23% rate forecasted at the outset of the reporting season.
The coming week also sees a number of key global economic releases, including Japanese leading indicators and the closely watched German IFO survey on Monday, US house prices on Tuesday, the Federal Reserve Open Market Committee decision and Chairman Powell’s press conference on Wednesday, German unemployment and inflation as well as US first quarter GDP and Japanese labor market data on Thursday, and German first quarter ‘flash’ GDP, US personal consumption expenditures (PCE) inflation and the University of Michigan inflation expectations survey on Friday.
We have strong confidence that the earnings data will be supportive for global equities. The rotation trade, from growth to value, may take a back seat if the information technology giants deliver significant upside surprises this week. But a combination of greater economic re-opening, untapped operating leverage and attractive valuations suggest any pause by cyclical, value and small capitalization stocks is likely to be short-lived. If global equity markets are to sustain their advance over the remainder of 2021, gains will have to be driven by rotation.
The biggest wild card and downside risk remains accelerating inflation. The economics profession continues to struggle with how to forecast inflation dynamics in a world of low and well-anchored inflation expectations. Investors, on the other hand, are becoming more alert to the risk of rising prices and wages. Inflation-protected bonds have enjoyed strong inflows this year and now discount US five- and ten-year inflation rates at their highest levels since 2013. That is the primary reason why the US yield curve has steepened sharply for maturities after 2024.
Yet despite some signs that investors are wary of accelerating inflation, overall market participants remain convinced by the Fed’s resolve, echoed last week by ECB President Lagarde, that central banks will remain steadfast in their provision of highly accommodative monetary policies. The US yield curve over the next two years remains as flat as a pancake. Neither bond nor stock market investors appear concerned, in the slightest, that the Fed or other central bankers might waver before then.
This means that investors remain ill-equipped to handle the risk of accelerating inflation. Accordingly, we’ll keenly watch the US core PCE release on Friday, which is expected to show a monthly acceleration of inflation to 0.3% and a year-on-year rate of 1.8%. While the latter remains safely below the Fed’s long-term 2.0% target and even further below its desired ‘overshoot’ in this cycle, it would nevertheless represent a notable jump from the current rate of 1.4%. And, as we have noted in this space before, even the introduction of doubt in investors’ minds about the commitment of central bank support to the recovery would be sufficient to derail bonds and stocks.
Inflation risk aside, the fundamental and relative cases for global equities remain strong and are likely to be reinforced this week. Corporate profits continue to beat analyst estimates by a solid margin and global economic data are mostly positive. To be sure, frighteningly high pandemic numbers in India are a reminder of potential global public health risks. They may also act as a brake on emerging market performance. But they do not (yet) pose a meaningful threat to the resumption of stronger global growth and earnings, above all in the US where over half of all Americans have now received at least one vaccination jab.
In short, global equities have solid support and few challengers. Rotation offers the path to stronger stock market performance. But keep an eye on inflation. It could yet be the wrench in the system.
