As US companies reported how much they earned over the fourth quarter of 2020 (the earnings season), a whopping 83% surprised positively. Yet markets didn’t move much on the news. So what’s going on and what could it mean over the coming months? Richard Dunbar, Head of Multi-Asset Research at Aberdeen Standard Investments, answers our questions.
Why were the results from US companies so surprising?
Financial analysts were expecting companies to report a decline in how much they earned during the final quarter of last year. But the majority surprised positively. And the level of improvement was an even bigger surprise – 17%, on average, higher than analysts expected.
Now here’s why this is a big deal. After companies’ profits declined by less-than-expected in the previous two quarters, analysts bumped up their expectations in the run-up to the recent reporting season. Yet companies still beat these. This is very unusual. Company managements normally encourage financial analysts to lower their expectations before companies announce their results – and this makes it easier for companies to positively surprise. You might think that everyone would be wise to this particular ruse by now – but (amazingly) no!
Has this ever happened before?
Twice before we’ve seen so many companies beat analysts’ elevated expectations for how much profit they’re making. It happened as economies recovered from the 2009 global financial crash. And again in 2017, as Trump announced tax cuts at the same time as other governments and central banks implemented supportive measures for their countries’ economies. This time feels a bit more like 2009, where analysts misjudged the scale of the recovery. Based on these examples, it suggests that this isn’t just a temporary anomaly.
So are we seeing the start of genuine economic recovery?
At Aberdeen Standard Investments, we believe there’s a real improvement happening in companies, even those not directly benefiting from our post-Covid ways of living and working. This is based on:
- a much stronger global economy than feared at the start of the pandemic (not good, but better);
- as well as the recent company results;
- and company actions that show their own confidence
Looking at the results, it’s not just the obvious beneficiaries of ‘life in lockdown’, such as technology companies, that are making money. Banks, industrial companies (especially those supporting increased activity in the construction sector) and transportation are also reporting encouraging results. Even some of those companies at the eye of the Covid-19 storm have managed to outperform expectations – restaurants have moved to a take-away service, closed shops have moved online and cinemas have become remote courtrooms. Managements and staff have played the bad hand dealt to them much better than most thought they would.
In addition, companies are indicating that they’re confident about the future by beginning to buy back their own shares again. In fact, we’ve just had the strongest January for buybacks ever. This had been a feature of many markets for a number of years but, for obvious reasons, had ground to a halt last year. Now however, companies – particularly (so far) in the US – appear confident enough to start to buy back their own shares, enhancing profits per share and using excess cash to make balance sheets more efficient.
How long will recovery take?
As I mentioned last month, the global economy has stood up to the financial rigours of the pandemic much better than most expected. Significant support from governments and central banks have provided life-lines, but so too has the ingenuity, flexibility and resilience of many companies.
Of course challenges remain, but we believe that the improvement we’re seeing in company earnings is genuine, sustainable progress. While much of the improvement is coming from the US, we expect that, in time, the rest of the developed world will follow.
There’s room for a sharp rebound in company profits and economic health as vaccine programmes progress and restrictions are lifted. But recovery to pre-Covid levels will take several quarters at least – though this is an outcome way ahead of what most were expecting in March/April last year. So it’s an improved and relatively good outcome but one that investors now accept. At Aberdeen Standard Investments, we’ll be keeping close to the companies we invest in to get a feel as to whether they can continue to build on this encouraging momentum.
But stock markets didn’t really react to the positive US company results - why is that?
Just because a company reports surprising profits doesn’t necessarily translate into bumper boosts to their share price. In fact, the shares of many US companies which beat expectations actually underperformed the market by a small margin. Investors had already reacted to more positive-than-expected company announcements over the summer and autumn, as well as announcements about the vaccines. But the share price falls were small – so the disappointment wasn’t too great.
What are the key factors for investors to watch over the coming months?
There are three important areas to watch:
- Vaccine roll-out and effectiveness against new strains of the virus: the optimism from companies and on the economic growth outlook is somewhat based on this – and as we’ve already seen, some countries are doing better than others in this regard.
- Maintenance of tax support from governments and low interest rates by central banks: as above, both these factors give comfort to investors and support some of the optimism in markets.
- The path of economic and business recovery: as we’ve already seen, there will be winners, losers and some unexpected outcomes of any recovery. So it’s crucial we keep talking to the companies in which we invest and continue to ‘do our homework’.
The information in this article should not be regarded as financial advice. Please remember that the value of investments can go down as well as up and may be worth less than was paid in. Forecasts are offered as opinion and are not reflective of potential performance. Forecasts are not guaranteed and actual events or results may differ materially. Information is based on Aberdeen Standard Investments’ understanding in March 2021.