Earnings keep rolling in and although estimates were lowered throughout September, the number of beats is consistent with prior, record-breaking quarters. Banks and financial companies always report first. With their sensitivity to interest rates, loans and consumer demand, they are a decent precursor for what’s happening in most industries. Loan growth demand continues to be lower than most economic recovery periods and interest rates hardly give investors a reason to over own financial center or regional banks. Consumers left this recession not only with decent balance sheets, but even better than pre-pandemic. No two markets are exactly alike and this period is certainly unlike anything we have ever seen before. Who knows when consumers’ and businesses’ excess capital wears off and the need for adding debt comes back.
Still, earnings per share metrics for banks have more than recovered. Even when backing out one-time reserve releases, EPS today are handily above 2019 for most. That is with minimal loan demand and interest rates near all-time lows. Valuations are also at decade troughs with many trading at a 50% discount to the S&P 500. Throw in solid dividend yields and huge stock buyback programs and you can see why the S&P Financial ETF is up 36% in 2021. These are early cycle stocks though, so the easy money has clearly been made. To keep on leading from here, one must believe interest rates will grind higher, loan demand comes roaring back, and consumer defaults hold at these decade low records.
Not to be outdone, numerous healthcare companies are rolling out with earnings updates as well. Covid induced tailwinds are helping many in the sector easily top estimates. Last quarter, not many understood the depths of Delta and its impact on testing, hospitalizations and equipment needed to slow the spread. Again, this is leading to solid beats albeit (hopefully) not something anyone should count on repeating next year. Those with great leadership, Abbot Laboratories# and United Healthcare# for example, have proven an ability to utilize hard fought, short-term gains into capital that can be redeployed into longer-term projects via mergers, acquisitions or capital expenditures. Those two companies in particular reported stellar earnings and are back near all-time highs.
Investors are pricing in an expectation that these investments will pay off in the future, not necessarily because of last quarter’s revenue windfalls. Consensus estimates for this sector in 2022 will be more difficult to top. There is over $100B in covid related sales that (again hopefully we’re beating this thing) will not be repeated. It won’t go back to zero but expect a significant drop off. Investing in this sector requires a realization that EPS next year could be down for many.
Outside of really good earnings reports, we have witnessed a sizable move in bond land. Recall back to the beginning of 2021, 10-year Treasury yields jumped from 0.92% to 1.75% by the end of March. Clearly, this was too far, too fast for everyone involved. Rates retreated before collapsing yet again due to Delta fears. Interest rates are a global market. US yields are directly tied to Japan, Europe and even some lesser developed markets. Rates can only get high enough before too much capital from international investors rushes in. Why anyone would want to own a 10-year German Bund with a negative return over something positive from the safer United States is beyond me.
When Delta cases ramped higher, nations reverted back to lockdown mode. This helped slow growth and cause a flow of capital back to the safety of bonds. Our 10-year Treasury went from 1.75% to a 1.12% low in August. Since then, it has been in risk-on mode and bonds are being dumped as rates now approach March’s highs, closing at 1.68% yesterday. How much of this is another bout of reopening optimism or a fear of inflation is anyone’s guess. Either way, we’re here and stock market participation has broadened out.
Encouragingly, many high-flying tech stocks that declined when rates popped earlier in the year are making new highs this time around. With predictable growth, those companies not dependent on low yields forever are taking a leadership role. Further, looking at our portfolios, I see new all-time highs for stocks in numerous industries as well: autos, railroads, banks, media, housing, storage, steel, computer, server, insurance and even retailers. That broad list of varied end-markets also contains some laggards. As we’ve noted, the rising tide will not lift all boats equally this time around. Companies need to prove industry leading attributes and pricing power to survive the middle stages of this economic rebound. Absent from the list of new highs are SPACs, consumer staples, utilities and other safety sectors who are being used as a source of funds to be redeployed in new leaders.
Lastly, more Capital Hill discussion on taxes is yielding an added shot of positive news for investors as it looks like the Progressive tax increase plans are crumbling. Senators Sinema and Manchin are from purple states with voter concerns about higher taxes with the Arizona representative standing firm in her position of being opposed to raising taxes on consumers or corporations. They also have a more moderate approach to economics than many in the Democratic party today. Lines in the sand have been drawn and Pelosi is noting the party needs to shift if these bills are to pass. This reconciliation bill has to follow strict rules; so any dollar increase in spending has to be met with an increase in revenues for the Government. The plan now is to put further emphasis on taxing billionaires, closing tax loopholes and identifying tax fraudsters. This is only going to produce a minor amount of income. Therefore, this spending package is coming more in-line with a realistic number as opposed to the $4T wish list that would surely be misspent. More progress is needed, but a smaller bill has a higher chance of getting through. Keeping corporate tax rates where they are removes a serious headwind for earnings growth in 2022.
Here’s hoping the good news keeps coming although last night’s earnings updates from several technology companies pointed to expanding shipment delays and a real issue with Apple’s iOS effect on competitor’s abilities to cope. Advertising revenues, in particular, will be a sticky situation. Why would anyone ramp up spending for ads when their product can’t be delivered in a decent time frame?
Stocks that miss or barely beat earnings estimates are being taken to the woodshed. Tax loss season is also upon us. Funky dislocations happen in these periods. Don’t throw the baby out with the bathwater. Some stocks will recover lost sales, others may have more structural problems. Breaking down their business lines and understanding the new norm is critical for investors today.
Next week is the busiest one for corporate earnings. It is time to see if this broad-based rally is deserved and new all-time highs will follow.
Jeff Goldblum turns 69 today. Deontay Wilder, who was just in one of the greatest boxing matches in recent memory with Tyson Fury, turns 36 today. One of the most recognizable characters from a favorite movie of mine, Back to the Future, Christopher Lloyd, is now 83.
James Vogt, 610-260-2214