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July 23, 2021

6 minutes to read

This story originally appeared on StockNews

Last week we saw some signs that the market may be ready to go down. Between last Wednesday and Monday’s low, the S&P 500 (SPY) was down 3.5%. Over the past two days, we’ve bounced back and made up for most of those losses. As noted in the previous comments, there is a tussle between the various bullish and bearish forces in the market. On the bearish side, we have a market with weak breadth, concerns about the Delta variant and signs that growth may have peaked. On the bullish side, we have low rates, an expanding economy and expectations of more earnings growth over the next 12 months. So far, this earnings season is also shaping up to be pretty strong, although some companies have published lower-than-expected outlook. In this week’s commentary, we’ll provide an overview of earnings and update our market outlook. Read below to find out more….

(Please enjoy this updated version of my weekly POWR Growth newsletter commentary).

Let’s start by looking at an hourly chart of the S&P 500 over the past month. Clearly, the market rebounded strongly from Monday’s lows and recouped about 2/3 of its losses.

During our webinar and previous comments, we discussed how this could come in the form of a patch or another garden variety dip.

Corrections tend to last for weeks, shifting sentiment from bullish to bearish and resulting in pullbacks of 7-15%. On average, we get about one a year. Troughs are quick withdrawals that are furiously bought.

Despite my belief that conditions were ripe for a correction, this price action is inconsistent with this assumption. In view of this development, I believe it is appropriate to gradually increase our risk exposure in our portfolio.

I’m particularly interested in tech opportunities, as the industry has been largely stable over the past six to nine months, as many names have shown impressive earnings growth during that time.

Winning season

We have often talked about the two main drivers of stock prices – earnings and interest rates.

In normal times, these compensate for each other. If profits rise rapidly, the Fed is likely to have a hawkish bias. Conversely, if companies are making less profit, the Fed is likely to ease the pain by cutting rates assuming they are not constrained by high inflation.

We are in a unique moment because they do not compensate for the moment. In fact, the interest rate picture has turned more bullish due to falling long-term yields, Powell’s conciliatory pullback during his congressional testimony, and the market’s belief that peak inflation is. transient.

Based on the few companies that have made statements and analyst expectations for this quarter, earnings growth will continue at an impressive rate.

Analysts expect second quarter profits to be 61.9% higher than last year. Of course, last year’s profits have been affected by the pandemic. Compared to Q2 2019 EPS for Q2 2021 for the S&P 500, it is expected to be 41% higher.

So far, around 20% of S&P 500 companies have reported. Among this group, 37 companies issued negative EPS forecasts, while 66 issued positive EPS forecasts. If this ratio holds, it would be the highest percentage of companies with positive EPS revisions since 2003.

A concern for many investors has been the S&P 500’s high price-to-earnings (P / E) ratio of 35.1, which is the highest level since the dot-com bubble. The bullish argument would be that this high P / E is justified given the pace of earnings growth. Granted, the market’s futures P / E is much more reasonable at 22.1, which is above its long-term average of 18.5 but not as blatant as the trailing P / E.

Here are some more specific topics that I am following this results season:

  • Impact of higher inflation: So far companies have complained about higher inflation, but there has been no impact in terms of margins or outlook. If the margins start to squeeze because of inflation, that would certainly be a negative development.
  • Buyout Announcements: Earlier we talked about the number of tech stocks that have continued to grow earnings even with their stock prices stable.

The combination of lower long-term returns and a cheaper valuation can lead to increased redemptions.

  • Energy / materials equities: On the one hand, these sectors recorded impressive performances. However, this was in line with the appreciation of the underlying commodity.

This means that there was no multiple extension. For example, VALE’s forward P / E is 5.2. One possibility is that the market thinks that the rise in iron ore prices is transient. So far, producers have behaved as if there was no significant increase in capital expenditure.

Lower CAPEX is part of my bullish thesis for the sector. So, until CAPEX goes up, I’m looking for energy and material stocks to use their profits to buy back stocks, as this could act as a catalyst and make them more attractive to investors.

Summary

Writing helps me clarify and organize my thoughts. Sometimes I come up with new achievements. Either I gain or lose conviction in an idea.

The strong market rebound and relentless price action lead me to conclude that the underlying bullish forces are crushing the bearish factors discussed in the past.

The earnings season is historically strong. The interest rate situation improved for equities with the fall in long rates and inflation expectations.

The next question is whether it will be a thinner lead like the one we’ve had in recent weeks or a wider rally like we’ve had for much of 2020 and beyond. early this year.

Growth stocks have underperformed since mid-February. However, that is changing as I have noticed that many growth stocks have actually hit higher lows than other stocks and sectors. This change in behavior makes me eager to add some high quality growth names.


SPY shares rose $ 1.85 (+ 0.42%) in pre-trade on Friday. Year-to-date, SPY has gained 17.77%, compared to a% increase in the benchmark S&P 500 over the same period.


About the Author: Jaimini Desai

Jaimini Desai has been a financial writer and journalist for almost a decade. Its aim is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the publisher of the POWR Growth newsletter. Learn more about Jaimini’s background, as well as links to his most recent articles.

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Margarita W. Wilson

The author Margarita W. Wilson