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It has been a subdued week thus far for US equity markets, though the S&P 500 is currently probing the 4200 level, just below record high levels. US equity market investors have had their hands full this week with a barrage of earnings; Google and Microsoft reported last night. Shares of the former leapt 5.1% higher as the company reported record profits for a second straight quarter and unveiled a new $50B share buyback programme, while the latter matched quarterly sales forecasts and beat profit expectations, but its shares fell 2.7% in premarket trading amid fears that profits had received a boost from one-off benefits included in the results and amid profit taking. Apple and Facebook are releasing earnings after the market close.
By the end of the week, 180 S&P 500 companies will have reported and, according to Refinitiv IBES data, Q1 earnings per share for S&P 500 companies is expected to jump 35% YoY given weak base effects, the largest surge since the Q4 2010. Broadly speaking, earnings so far have been going well, with four out of five companies beating analysts expectations on top and bottom lines, according to newswires. Should earnings continue to surprise to the upside over the coming weeks, this will provide stocks with a nice tailwind, just as was the case during the Q4 2020 earnings season at the start of the year.
Turning away from stock specific news to notable macro events, things are set to hot up over the next few hours; the FOMC will be releasing the result of their latest monetary policy decision at 1900BST/1400EDT followed by the usual press conference with Fed Chair Jerome Powell at 1930BST/1430EDT. US President Joe Biden will address a joint session of Congress from 0200BST/2100EDT where he is expected to unveil further details about his American Families Plan proposal.
Beginning with the former; no new economic forecasts will be released, so traders will eye the bank’s updated statement for evidence as to whether the Committee’s view on the US economy has improved or not (given strong recent data, more positive language is likely). Despite optimism about the outlook, the Fed is expected to maintain its dovish guidance (no tapering of QE until substantial progress made towards inflation and employment goals and no interest rate rises until inflation sustainably above 2.0% and full employment); Fed Chair Powell is likely to hammer home the point that the economy remains a long way from the Fed’s goals and until all of that slack is absorbed, there will be no rate hikes. Markets will also look for any hints as to what economic criteria might enable the Fed to start tapering asset purchases.
In terms of what all of the above means for stocks; the more dovish Fed Chair Jerome Powell comes across on policy guidance the better. In fact, the best-case scenario for stocks is most likely if Powell just completely shrugs off any questions about asset purchase tapering as he has done so far this year. Most analysts suspect that the Fed will start to taper towards the end of the year or early next year. Powell will know this and is unlikely to want to bring these expectations any further forward given that such an outcome would be negative for stocks.
The most likely outcome at today’s meeting is that Powell refuses to be drawn into the specifics on the economic criteria the Fed wants to see to taper, or on when the Fed might taper, and instead keeps things vague by reiterating that the bank wants to see “substantial” “actual” progress towards its inflation and employment goals. Combined with the bullish outlook the Fed is likely to espouse for the US economy’s recovery prospects over the coming months, it is difficult to see how this could be negative for stocks.
President Joe Biden’s infrastructure spending announcement to Congress overnight has much greater scope to be a negative for stocks given the increased focus in recent weeks on raising taxes on the wealthy to pay for all of his spending plans. However, stocks already took a little tumble on Biden taxation policy fears last week (on reports he would bring capital gains tax in line with income tax) and have already since recovered. As far as stocks are concerned, the more President Biden wants to fund his plans with debt, the greater the fiscal impulse (and likely the higher the growth and inflation), and the better for stocks. If equity investors in the Asia session like what they hear, watch how US index futures (e-mini S&P 500 futures, for example) react overnight for a gauge as to how US players might react to the news once markets open on Thursday.
Looking further on this week, the preliminary estimate of Q1 2021 GDP growth in the US is set for release on Friday following another round of weekly jobless claims numbers on Thursday. The former is likely to show the US economy expanding at an annualised pace of at least 6% in Q1, a pace which is set to accelerate in the quarters ahead as the vaccine rollout reaches critical mass (herd immunity in the US is arguably already close) and the economy reopens and returns to “normal”, freeing up what is expected to be a huge wave of pent-up demand and savings. The Fed is currently forecasting that the US economy will grow 6.4% in 2021. Arguably, this rosy outlook is already baked into stock prices, however, so the reaction to the data is likely to be somewhat muted.
However, the months ahead will be very interesting, and most analysts agree that the path of least resistance for stocks continues to point upwards; as the above forecasts for the economy actually come into fruition without downside risks (such as a resurgence of the pandemic via a potentially vaccine resistant strain of Covid-19), ongoing relief that the pandemic is increasingly in the back rear view mirror will arguably offer ongoing support. Moreover, barring a huge mistake from the Fed today, expectations are likely to continue to be that there will be no tapering of the Fed’s QE programme until later this year – ongoing ultra-accommodative monetary conditions are set to be another ongoing tailwind for stocks.
Perhaps than the biggest risk for stocks might be over-exuberance, as has so often been the case in the past. Indeed, a number of banks this week called for a profit-taking related pullback in equities that would bring valuations back to more reasonable levels; for reference, the S&P 500’s current price to earnings ratio is 42.68, well its average range of the last decade between the 15-25 area, though still well below pre-global financial crisis levels. Note that earnings are likely to surge in the coming quarters as the pandemic recedes and business see their usual demand return, which should put downwards pressure on this ratio.
Seeing this surge in earnings occur in 2021 come into fruition might ease some of the angst currently being felt about valuations. Alternatively, a “healthy” 10% correction in stocks might be what is needed to do as much. Rest assured though that as long as the macro-backdrop for equities remains as favourable as it is looking right now, investors will be climbing over each other to buy that dip.
