Though stock prices gyrate day by day in reaction to news, in the long term the stock market reflects company profits. As we end this second quarter, I would like to share with you an article put out today about company profits in the second quarter and beyond by JP Morgan, one of the Portfolio Strategists we utilize for client accounts.
Since the onset of the pandemic, earnings have surprised to the upside by a significant margin. While analyst estimates are typically reliable, it seems likely that many models grossly underestimated the strength and pace of the economic recovery, leading to earnings projections that were overly pessimistic. That being said, with the 2Q21 earnings season approaching, we believe that earnings will come in well above current estimates, and are forecasting an earnings surprise of 14.6% for the S&P 500. This would represent a decline from the 23.7% surprise observed in 1Q21, but would still be above the long-run average of 7%.
Going forward, earnings growth will hinge on the resiliency of profit margins. Revenue growth should remain robust through year-end, but at the same time, companies will continue to be faced with cost increases due to supply chain disruptions and higher wages. If firms can defend margins by increasing prices, inflation may move higher, pushing the Federal Reserve to pull forward its plans for tightening and potentially weighing on earnings growth. However, if firms find that demand is elastic and price increases lower revenues, they will need to find alternative levers to preserve profits. The bottom line is that earnings growth seems likely to slow as we approach 2022, but this does not seem to be reflected in analyst estimates. This suggests that estimates may need to decline if a trend of elevated surprises is to continue.