As the earnings season for the second quarter begins, investors will be looking for new signs of growth in corporate revenues and profits. This is important because the conversation continues to shift from recovery to expansion as the economic impact of the pandemic fades and inflation heats up. Whether the bull market can continue and lofty valuations can be justified will depend largely on whether the economy can find a new gear to sustainably grow.
The economy is recovering more quickly than expected
Current Wall Street estimates suggest that S&P 500 profits returned to pre-pandemic levels of $164 per share during the second quarter, mirroring the expected recovery in GDP across the broader economy. This is faster than expected and would represent a 38% growth rate in 2021 and 21% over the next twelve months. As recently as the beginning of the year, the market didn’t expect a full recovery until the fourth quarter. A full recovery during the second quarter means that the recession in earnings only lasted four full quarters, rather than nearly two years.
Chart: S&P 500 earnings-per-share estimates are back to pre-pandemic levels
Sources: Clearnomics, Standard & Poor’s, Refinitiv. January 29, 2021
Investors benefit as companies earn more
This is especially important since the recovery, driven in no small part by pent-up demand, is most likely already incorporated into stock prices. The ongoing bull rally, which has provided investors with double-digit percentage gains across major indices this year, has kept valuations such as the price-to-earnings ratio high even as earnings growth has accelerated. The economy may need to reach a new gear of organic growth in order to propel markets further. Growth expectations can become self-fulfilling prophecies if businesses invest to meet new demand and consumers spend because they feel more financially confident.
Of course, investors don’t invest in the economy directly. Instead, when the economy grows, investors benefit as companies that they are invested in earn more which supports stock prices over time. Some sectors saw immediate earnings boosts one year ago due to the acceleration of digital transformation, the spending of stimulus checks, buying goods online, and more. This growth has broadened as commodity prices and interest rates have risen, benefiting sectors such as energy, materials, financials and more.
Stay in the game by investing for the long term
Ultimately, investors should continue to focus on earnings and valuations since, in the long run, they are what primarily drives stock market returns. Although there are always uncertainties, history shows that those who are able to stay invested throughout the business cycle, especially when profits are rising, can improve their odds of financial success.
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Put your investing on autopilot
It’s generally best to avoid moving your money in and out of the market to try and capture the performance highs and avoid the lows. That’s called market timing, and it’s extremely risky. Instead, consider setting up an automatic investing plan. You’ll invest a set dollar amount at regular intervals, regardless of market swings. It’s a nearly effortless way to consistently invest money for your goals. And in the end, you’ll end up buying the average price of an investment, which is exactly what you’d want to achieve in the long run. Remember, investing even small amounts can really add up over time.
Disclosures
This material, as well as the insights and data within, have been provided to MoneyLion by Clearnomics, Inc.
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