Avidian Report – Lets Talk About Earnings

INSIDE THIS EDITION:

Over the first two quarters of 2021, the S&P 500 rose from 3756 to 4297. In the third quarter, however, the pace of its price rise took a brief pause, only increasing from 4297 to 4307, which amounts to 0.20%. Analysts believe the S&P 500 will regain strength and see a price increase of 14.8% moving into 2022.

Whether this happens might be predicated mainly on corporate earnings. As a point of reference, earnings are expected to have grown during the third quarter by nearly 28% on a year-over-year basis. While earnings results may come close to that estimate, signs of a tight labor market could drive wages higher and make it increasingly difficult for corporations to exceed lofty profit expectations.

As the chart below shows, labor demand has never been stronger, with the unemployment rate dropping sharply after a pandemic-driven spike in 2020. At the same time, job openings that employers have been unable to fill have also gone up considerably.

Source: Macrobond and Nordea

This often leads to increasing wages. We have already seen some wage pressure on the lower end of the wage scale. However, it remains to be seen whether we see a similar pressure build for higher wage positions.

That said, it appears that employers are planning for wages to increase over the next year. As the chart below shows, we see a record for planned wage increases according to data collected by NFIB.

Source: Macrobond and Nordea

Further, should wage pressure either broaden or continue to rise, the combination could begin to put more considerable pressure on profit margins next year.

Source: Macrobond and Nordea

Companies may be taking this genuine possibility into account. Take, for example, the chart that follows that shows the Guidance Index from Bianco Research. It is designed to represent a reading of how many companies are guiding higher compared to lower ahead of their earnings reports.

When taking the upside guidance and subtracting downside earnings guidance, and adding in ½ neutral guidance, we get a net result as of October 8 that shows a positive guidance reading. However, more interesting and perhaps more important is that since June 21, 2021, the October index reading has been down approximately 20%. And it looks like a short- to intermediate-term trend may be developing as we have now seen three consecutive quarters where company-issued guidance is compressing.

What does all this mean for stock price performance? We sense that if margins compress, we might see additional price gains contained and perhaps even some selling pressure, especially if earnings results fall short of their expectations. This is the result of a post-earnings-announcement drift, defined as the tendency for a stock’s cumulative returns to drift in the direction of an earnings surprise in the weeks and months after the announcement.

Looking at the chart below, we see a larger number of stocks fall in price after posting their earnings results. While the chart only looks at performance results the day after earnings are announced, one-day performance after earnings are released could indicate short-term share price direction.

For investors, this could indicate the direction of broad equity indices in the short- to intermediate-term. For investors, we think this highlights the importance of watching earnings expectations and whether companies fall short, meet, or exceed them.

Weekly Global Asset Class Performance

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