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April 13, 2021, 7:59 a.m. EDT

Corporate earnings growth could hit a decade-high despite COVID-19 pandemic

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By Emily Bary

After lapping the beginning of the COVID-19 pandemic, companies could show the strongest profit growth in more than a decade as earnings season kicks off in the coming days.

Analysts expect S&P 500 /zigman2/quotes/210599714/realtime SPX +1.49% to post profit growth of 24.6% for the first quarter of 2021, according to FactSet estimates, which would mark the highest quarterly growth rate since 2018. Companies have a tendency to deliver results ahead of expectations, though, and they’ve been beating estimates by an especially wide margin during the pandemic, leading FactSet Senior Earnings Analyst John Butters to suggest the S&P 500 could deliver earnings growth of 28%, which would mark the best growth in more than 10 years.

The first quarter is a bit unique, as results from the past three months will be compared with a year-ago period that saw about two months of normal performance before COVID-19 lockdowns disrupted the economy. Analysts are calling for a dramatic improvement from last year’s performance that would kickstart a blockbuster year of earnings growth after multiple earnings recessions in recent years.

Some of the strongest categories in the first quarter should be those that stand to benefit the most from an economic recovery. Analysts are looking for earnings growth of more than 100% within the consumer discretionary sector, despite continued weakness in hotels and cruise lines. The financial sector is next, with expected earnings growth of 79.5%, and banks kick off the earnings parade later this week.

“Banks tell you a lot about the economy,” including whether consumers or corporations are driving loan growth and whether consumers still are struggling financially even with recent stimulus payments, said Bill McMahon, the chief investment officer for active equity strategies at Charles Schwab Investment Management.

See also: Stocks slip from record high as first week of earnings season begins

He’ll be interested to see the performance of cyclical names against defensive ones, following big run-up in cyclical stocks amid recent vaccine progress as defensive stocks have lagged.

“Are cyclical expectations so high or are defensives too low?” McMahon asked.

The industrial and energy sectors are projected to be the biggest detractors from S&P 500 earnings growth, with analysts surveyed by FactSet calling for a 17.3% profit decline in industrials and a 17% drop for the energy sector.

“Energy didn’t fall off a cliff until the second quarter” of 2020, CFRA Chief Investment Strategist Sam Stovall said, but “2021 will definitely be a shift from outright loss to actual profits.”

While the industrials sector “did not post outright losses,” the sector was “down as much as 81% in Q2 [2020], so earnings shrank dramatically and will be recovering quite nicely,” he continued.

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Analysts are feeling increasingly optimistic about overall corporate performance, with the current expectations for 24.6% earnings growth up from 15.7% growth that analysts tracked by FactSet were predicting as of the end of December.

Corporate profits continue to recover following a surprise 3.9% increase in earnings in the fourth quarter that snapped the S&P 500 out of its latest earnings recession, but the most dramatic performances await when companies report their second-quarter numbers, given that the corresponding period a year ago saw the biggest impact from the pandemic.

Analysts tracked by FactSet now expect 53.2% profit growth for the second quarter, up from the 45.4% increase they expected as of late December. Expectations for strong earnings momentum helped push stocks upward in recent months, and the question is whether companies will be able to meet that high bar for a recovery.

“There’s an awful lot of enthusiasm in the market right now,” Stovall said, with a forward price-to-earnings ratio of 23.5, a 40% premium to the average since 2020. “Either the market has to come down in price or earnings have to really come up a lot more than is currently anticipated.”

McMahon will be looking for “signs of resumption of normal activity” as management teams discuss early second-quarter trends, though he notes that despite expected rebounds for areas like travel and energy, investors may need to “temper enthusiasm” for technology companies that performed well during the pandemic. In addition, investors following multinational companies should take into account that many parts of the world haven’t been vaccinating their populations at the same rate as the U.S., which could impact recovery timelines.

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