One factor about the equity market is its movements are often influenced by expectations. Economic news that is reported better than those expectations can impact broad equity market prices and earnings that beat expectations are an important variable impacting the price of stocks too. For the broader market, in this case the S&P 500 Index, earnings expectations for 2021 appear to have bottomed as the hook at the end of the red line on the below chart shows. Also important is earnings growth is expected to resume with an increase of 26% in 2021 versus 2020 and a further 16% increase for 2022 versus 2021.
As the virus mandated economic shutdown took hold in February, the original earnings expectation for 2020 fell from over $200 for the S&P 500 Index to around $122. This dramatic decline in earnings certainly had a negative impact on stock prices. The S&P 500 Index fell nearly 34% from the pre-virus shutdown February 19 high to the March 23 low, which almost matches the percentage earnings decline.
As more states open up their economies, economic activity continues to expand. Recent economic releases are supporting this viewpoint as well. With a pickup in the economy, companies are once again experiencing growth in their businesses. Analysts’ views on earnings reflect this as upward earnings revisions exceed downward revisions by almost 2.5 times.
The difficult question facing investors is knowing how much of this improved economic and earnings environment is factored into stock prices already. Given the stock price reaction to some recent earnings releases, one could say all of this favorable news is not factored in. However, when a $200 billion market cap company like Salesforce.com (NYSE:CRM) sees a 25% jump in its stock price based on its recent earnings release, maybe some speculation is entering the market. Having noted this, in a low interest world like investors are dealing with today, stocks can and will trade at a higher valuation level. The margin for error, though, has certainly narrowed.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.