Is The Market Getting Ahead Of Itself?

The Standard & Poor's 500 Index hit a record high seven times in a row-the longest continuous increase since 1997. Last Friday, Nasdaq and Dow Jones Industrial Average, which were once in trouble, also hit new highs.
For companies in the Standard & Poor's 500 Index, analysts now expect the profits in the second quarter to be 64% higher than the profits in the second quarter of 2020, which is undoubtedly seriously hindered by the COVID blockade.
Due to our sudden national blockade, the performance in the second quarter was very strong, contrary to the weakest single quarter since the Great Depression.

The evidence is growing that this market knows no fear. There has been no 5% correction (on a closing basis in the S&P 500) since before the last election, according to James McIntosh, writing in The Wall Street Journal on June 27. The S&P 500 has set seven all-time record highs in a row - the longest streak since 1997. Last Friday also brought new highs to the once-struggling NASDAQ and Dow Industrials.

Starting next week, we will begin hearing from major companies regarding their second-quarter earnings. How good will they be? Very good. Let’s start with what we already know. The broadest measure of U.S. corporate profits is the National Income and Product Accounts (NIPA), including all public and private companies. According to data from the Federal Reserve Bank of St. Louis, released June 24, 2021, year-over-year growth in NIPA after-tax profits is +28.1% from the first quarter of 2020 to the same quarter in 2021. The first quarter also represents a 7% increase over the last quarter of 2020, which is an annualized increase of over 30%. There’s a chance that the rate of increase for the second-quarter 2021 profits will be over 50%, since 2020’s second quarter was so depressed. Here is a chart of after-tax corporate profits:

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Critics sometimes allege that companies inflate their earnings, but nobody says corporations inflate their taxable income! If anything, companies want to avoid taxes, just like anyone else, but their taxable profits just keep rising, and over time, S&P 500 earnings per share (EPS) tend to track the trend in NIPA profits.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

For the companies in the S&P 500, analysts now expect second-quarter profits to come in 64% better than those in the second quarter of 2020, which was admittedly badly handicapped by the COVID lockdown, but consider this: Second-quarter 2021 earnings are also expected to be 8% above the boom-time 2Q 2019 earnings, so this means our corporations have grown a net 4% per year in earnings through the pandemic!

Analysts usually underestimate earnings - that’s why there are consistently more positive surprises than negative surprises during most reporting periods. Back in April, these same analysts were predicting that second-quarter earnings would be up 54%, a full 10 points lower. Could they still be underestimating 2Q earnings? Could the final number be well above 64%? Perhaps, but don’t expect to see numbers that high ever again, perhaps in your lifetime (even if you are young), since a very strong second quarter is going against the weakest single quarter since the Great Depression due to our sudden national lockdown. Economist Ed Yardeni is projecting earnings growth to “slow” to 22.9% in the third quarter and then +16.6% in the final quarter. If my math is right, that makes for an average of about 37% for the full year.

Analysts were way off the mark in forecasting the first quarter of 2021. At the beginning of the year, the consensus was that S&P profits would be up 16% in the first quarter (vs. the same quarter in 2020), but first-quarter profits for the S&P 500 were up over 48% in the opening quarter. At one point, we thought that would be the all-time high growth rate, but it looks like this quarter will surpass Q1 by a long shot.

There is still a record amount of money on the sidelines available to pour into stocks on any small (under-5%) correction. That’s why we haven’t seen any big corrections since October. M2 money supply is still near record highs, up $5 trillion since the start of 2020, while demand deposits (checking accounts) at commercial banks are up $2.4 trillion in the same 18 months, and our savings rate is at multi-year highs.

In addition, investors know There Is No Alternative (TINA) to stocks. Treasuries, bonds, cash, and now even junk bonds earn negative real (after inflation) yields, while bitcoins and most commodities are clearly risky, since inflation can be “transitory” in many commodities as supply chains come back in line.

So, no, I would say stocks are not “ahead of their skis,” nor are most investors “too complacent” now.

All content above represents the opinion of Gary Alexander of Navellier & Associates, Inc.