The way price responds to news is always more important than the information itself. It is difficult to imagine a more bullish macro backdrop for equities. Monetary and fiscal policy is exceptionally loose (with the promise of even “more”) and liquidity is super abundant. Earnings growth and profits relative to expectations are near the strongest on record. However after an impulsive rally from the February low, price momentum has stalled since around mid-April. From our perch, the price action overnight was particularly telling after results from the mega cap technology companies. They blew away expectations. That the market failed to advance on barnstorming results suggests that the good news was already well priced.
As we entered 2021, investors hoped for a further significant increase in fiscal stimulus and broad vaccinations to facilitate opening up of the real economy and match exceptionally easy monetary policy and super abundant liquidity. Despite the lack of a large majority, the Biden Administration has delivered material additional stimulus with the promise of even more to come. While some of the fiscal spending might be pared back the size of the budget deficit (and the fiscal impulse) is already comparable to War time stimulus. While the Federal Reserve remains in crisis mode and still worries about the unemployment gap the strong economic and corporate news flow has been extremely supportive for equities despite the rise in rates from the start of the year. The big picture point is that policy remains extremely supportive for the capital markets even though the economic news flow has been well ahead of expectations.
The trend in corporate profit growth is also close to the strongest on record as the global economy begins to re-open from the pandemic shut down a year ago. The incredible level of excess liquidity and pent-up demand (from high savings rates) has led to the highest level of manufacturing and services data on record as vaccinations run ahead of schedule in the United States. The fear and uncertainty about potential economic growth has largely disappeared. That has been reflected in corporate earnings and also in reduced volatility aversion among investors (evident in the sentiment surveys that are around 2 standard deviations above neutral). Prior to the March reporting season, bottom-up consensus expectations were for 24.5% growth compared to the same quarter one year ago. With around half of the results reported, growth expectations have increased to +44.7% (the highest growth rate since Q1 2010). According to Refinitiv, 86.8% of S&P500 companies have reported above consensus by a magnitude of 23.5%. Both are the highest on record.
As we noted last week, a number of tactical and sentiment indicators are flashing red. They include sell-side measures of risk appetite (near euphoric/contrarian levels), the net AAII survey at around two standard deviations above neutral, low demand for put relative to call options and 96% of individual stocks in the S&P500 trading above their 200 day moving average. Volumes have also been falling as the S&P500 (the global risk proxy) has made new highs. However, from our perch it was particularly telling how price responded to the exceptionally strong earnings news flow this week.
Of course, it is important to note where we are in the economic and market cycle. While this episode appears to be moving at warp speed, the expansion is probably still only mid-cycle. Equities tend to out-perform until the output-gap (unemployment gap) closes and that is still relatively wide. Policy and liquidity are still extremely supportive and equities still offer a decent premium relative to sovereign bonds and credit. That said, there is decent odds of a near term consolidation or correction before a renewed advance in price. If equities could not advance following the exceptional corporate results this week, the good news is probably well priced.
About the Author:
Nick Ferres is CIO of Vantage Point Asset Management. Prior to this, Nicholas was at Eastspring Investments, the Asian asset management business of Prudential plc, as Investment Director, in September 2007. Nicholas was Head of the Multi Asset Solutions team and was responsible for managing the global tactical asset allocation of funds for external institutional and retail clients. Before joining Eastspring Investments, Nicholas worked for Goldman Sachs Asset Management as Investment Strategist & Portfolio Manager. He has more than 20 years of financial industry experience. Nicholas holds a B.A. (Hons) in Economic History and Politics from Monash University, Australia, a Graduate Diploma in Economics and a Graduate Diploma in Applied Finance.