April 2021 | Equity Commentary

Published on May 10th, 2021

April 2021 | Equity Commentary

Market Overview

The good news continued in April, with the S&P 500 index crossing 4,000 for the first time. The U.S. economy posted real GDP growth of 6.4% in Q1, nearly surpassing the pre-pandemic level of GDP. Earnings season in the U.S. is also off to a strong start, with better-than-expected results arriving as pandemic risks fade into the background. In our view, growing optimism is being reflected in sustained investor appetite for risk assets.

Earnings season is in full swing, and early signs indicate American corporations are in robust financial health. As of April 30, 87% of reporting S&P 500 companies delivered better-than-expected results, which is far higher than the historical average of 65%. Should the trend largely hold, corporate America could deliver the highest share of quarterly earnings beats since 1994.

Importantly, corporations are not just barely beating estimates—they are surprising significantly to the upside. According to data firm Refinitiv, corporations have historically beaten estimates by an average of 3.6%, but so far in Q1 2021, profits have been averaging 22.8% above expectations. All told, the recent string of strong results has S&P 500 companies on track to post their fastest rate of earnings growth since at least 2010. The caveat is that corporations have the benefit of coming off historically weak comparisons in 2020, but at the same time, earnings have rarely looked this good.

Retail sales and capital goods orders have surged beyond prior cycle peaks, which suggests more upside to S&P 500 revenue forecasts in the coming months. After the 2008 Financial Crisis, it took retail sales and capital goods orders 41 and 46 months, respectively, to pass prior peaks. In aggregate, these economic readings suggest the US economy is experiencing one of the strongest recoveries in decades.

The labor market is also showing signs of marked improvement, with the number of job openings very close to its pre-pandemic peak. Weekly unemployment claims and monthly layoff announcements have fallen to post-pandemic lows. In the Fed’s recently published Beige Book, a common theme emerged: employers were reporting shortages of workers, and many said they were having difficulty hiring. Among the areas reporting the most shortages: drivers, entry-level workers, childcare, nurses, and information technology. In other words, a fairly diverse range of jobs.

The labor force is estimated to be 5 million lower than it was before the pandemic, as many people dropped out of the labor force for a variety of reasons – boomers retiring, women staying home for childcare, people fearful of catching and spreading the virus, and/or folks who are content living on expanded unemployment benefits. But the large number of job openings—and employer frustration in filling them—may be best explained by the Economic Policy Institute’s Heidi Shierholz: “One reason is that in a system as large and complex as the U.S. labor market, there will always be pockets of bona fide labor shortages at any given time. But a more common reason is employers simply don’t want to raise wages high enough to attract workers. Employers post their too-low wages, can’t find workers to fill jobs at that pay level, and claim they’re facing a labor shortage.” April’s weaker-than-expected jobs report – with U.S. employers adding 266,000 jobs versus the expected 1 million – may be anecdotal evidence of Ms. Shierholz’s theory playing out.

Only a few weeks after the passage of the $1.9 trillion American Rescue Plan, President Biden is now pushing another $1.8 trillion package called the “American Families Plan” (this in addition to the $2.3 trillion infrastructure plan). This plan aims to expand educational opportunities and childcare, funded partly by the largest proposed tax increase on wealthy Americans in decades. The initial proposal for tax increases includes pushing the top marginal rate for individuals to 39.6%, increasing corporate taxes to 28% from 21%, and raising capital gains taxes to 43.4% for individuals who earn over $1 million annually, inclusive of the 3.8% net investment income surtax. Treasury Secretary Janet Yellen is also negotiating with foreign allies to institute a global minimum corporate tax.

It’s quite a bit to digest. Government spending feeds directly into GDP growth, but higher taxes can create distortions in the markets, particularly if the capital gains rate is doubled for a slice of the population. Efficient allocation of capital is another story altogether. At the end of the day, we know from history to watch what politicians do, not what they say. With a narrowly divided Congress, many of these proposals will likely be watered down if they make it to the finish line at all. The biggest risk to the markets in the interim, in our view, could be the legislative uncertainty to follow.

The U.S. has arguably turned a decisive corner in the battle against Covid-19. Hospitalizations in Michigan – the worst hot spot in the U.S. – are falling again, and some states are reporting zero new coronavirus deaths for the first time in a year. More than half of American adults, or close to 150 million people, have received at least one vaccine dose. In the EU, officials have finally accelerated the pace of vaccinations to the point where they are above the rate in the U.S., helping to spur a material downturn in new infections there. Brighter days look to be ahead.

As of April 30, 2021

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