With the Q3 earnings season nearing the end, it has been another strong reporting season for companies. Earnings growth is up more than +41%, and revenues are set to expand by nearly 17% (table below). This compares to the expected growth of +27.5% for earnings and +14% for sales before the reporting season started. As a result, this has been yet another quarter where reported results were significantly better than the initial estimates.

Source: Strategas Research Partners

After an extraordinary move higher, the next 12-month estimated operating margins have been nudged lower, now standing at 17.1% (chart below). Some commentators are pointing to this margin decline as the first fundamental blemish we have seen for companies as we approach year-end. The metric does bear watching. However, such a small retracement from historic highs in the context of severe supply-chain disruption and input cost inflation may also be seen as evidence of the current resilience of corporate profitability in a strong demand environment.

Source: Strategas Research Partners

Some further budding investor concern over the sustainability of corporate earnings may also be gleaned from the direction of 2022 estimates while 2021 estimates continued to be revised higher. The chart below shows that next year earnings expectations have been held stable since the summer. The implied growth rate for 2022 (+8%) now stands at the lowest level since these estimates were first introduced. This would suggest that analysts interpret the strong earnings upgrades in 2021 as borrowing from 2022 growth.

Source: Strategas Research Partners

Maybe it can be partially explained by these growth concerns, or maybe it is simply a Pavlovian investor addiction to what has worked in the past, but the chart below highlights that on at least one valuation measure (EV/Sales), the valuation spread between the most expensive and least expensive stocks in the index are now in 2000 internet bubble territory. It is quite extraordinary that this valuation gap has widened in 2021 with both interest rates rising and the relative earnings growth of the cheapest stocks outpacing that of the most expensive.

Source: Strategas Research Partners

As highlighted in previous updates, the difference this year as compared to 2020, is that money flows are being primarily concentrated in the mega-cap Growth stocks. The chart below shows the growing concentration risk of the U.S. index as the largest names continue to attract investor flows. On this measure, the concentration risk of the index supersedes that of 2000.

Source: Strategas Research Partners

In our judgment, the weight of evidence continues to back a pro-cyclical investment positioning despite the persistent headline fears. The chart below shows the trend in economic surprises (actual reading versus prior expectations) in the three most important economic regions. Economic surprises have been in a downtrend since April – that is expectations proved too optimistic against a backdrop of rising political tension, further covid outbreaks, supply chain disruptions, etc. However, also of note is that all three regions have seen an uplift since early October, lead by the U.S. We suspect that as positive trend persists, analysts will need to start upgrading their 2022 earnings estimates.

Source: Strategas Research Partners

The second chart below has been updated to show the strong similarity in stock performance between this year and 2013. 2013 and 2021 have been unique in the number of looming political issues that require(d) resolution (first table). 2013 showed that as each issue was resolved the market kept climbing. 2021 is following that trend and with the expected imminent resolutions of the Fed Chair appointment, Biden’s spending plan and the debt ceiling, a positive end to the year seems likely.

Source: Strategas Research Partners