Will Corporate Profits Support Stock Prices?

As the economy continues to recover from the pandemic, it’s likely that corporate profits will follow suit. How long this process takes and whether there are hiccups along the way will depend on many factors such as the ongoing public health response, the return of business and consumer demand, the health of financial markets, as well as short-term uncertainty around the presidential election. What can investors expect of corporate earnings in the year ahead?

When Is a Full Recovery Expected?

At the moment, many economists expect GDP growth in the third quarter to have exceeded 30% on an annualized basis. This would be an extraordinary bounce after economic growth collapsed in the second quarter. In general, a full recovery isn’t expected to take place until the end of 2021 for both the economy and earnings, representing about two lost years of growth.

Of course, investors don’t invest in the economy directly. Instead, when the economy heals, investors benefit as companies see improved financials which support stock prices.

While current estimates suggest that full-year 2020 earnings will fall by almost 20%, they are then expected to rebound by 26% in 2021 for a full recovery. Some sectors have already seen earnings boosts due to the acceleration of digital transformation, the spending of stimulus checks, and more.

Chart: The S&P 500 index price versus earnings-per-share. Over the long run, the stock market follows earnings which in turn follow the economy.

Sources: Clearnomics, Standard & Poor’s, Refinitiv

Many Developed Markets Have Similar Growth Expectations

This pattern is not unique to the U.S. stock market but can be seen across major regions. Developed markets, driven by Europe, are expecting earnings to grow by 22%. Emerging markets expect similar growth of 24%. Globally, public companies are expected to grow their earnings-per-share by almost 19%. Again, whether this comes to fruition will depend on many factors with the public health response to COVID-19 being the most important.

An important component of the domestic economic rebound has been the CARES Act and other government support measures. While their true impact may not be known for some time, it’s likely that stimulus checks and the Paycheck Protection Program helped to boost confidence and keep consumers and businesses on life support. This was especially important in March and April when the nationwide shutdown was occurring. At the moment, a second round of stimulus is still pending negotiations in Washington.

Focus on Corporate Earnings and Valuations

Ultimately, investors should continue to focus on corporate earnings and valuations since, in the long run, they are what drive stock market returns. While this was difficult to do during the height of the crisis, there are many signs that the recovery can continue through 2021. Although there are still many uncertainties, history shows that those who are able to stay invested when times are tough can often improve their odds

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