Strong S & P Earnings and Margins Outlook

Investing is a process requiring a long-term perspective while recognizing that market corrections can always occur. We pride ourselves on correctly identifying long term investable trends and investing accordingly.  The pundits, however, turn on a dime, following the market, rather than anticipating what will happen over the next few years based on the data collected. That’s just what happened after Thursday’s decline. We view corrections as opportunities.   Unfortunately, program trading can extenuate market moves regardless of fundamentals. It’s important to put emotions aside and focus on fundamentals.


Excess Liquidity, low-interest rates, and fiscal stimulus have been the driving forces behind the markets’ rise to date, but the times they are a-changing. While it may take two years for the economy to return to pre-pandemic levels, we believe that the full earnings recovery will come much sooner as operating margins increase back to and past historic highs–above 12%. The pandemic has forced management to take a hard look at all its costs and many have found that they can do more with less and executing work remotely cuts costs. The use of technology has been accelerated in all facets of a company’s business from administrative to sales to operating efficiencies from the top to the bottom of an income statement.


The Fed notes that came out Wednesday acknowledged that the human resources furloughed may never come back to work. Unfortunately, this means that unemployment will remain higher, which has long term implications as the economy comes back. It also means that productivity will be increasing meaningfully as the economy recovers which limits increases in unit labor costs and inflationary pressures while boosting operating margins and profitability.


We are now estimating S & P 500 EPS of $126/share in 2020 down from $163/share in 2019 but rising to $165/share in 2021 and $185/share in 2022 assuming no changes in tax rates. We estimate that fourth-quarter 2020 earnings may reach and/or possibly exceed fourth quarter 2019 earnings of $42/share which would be the first positive year over year comparison. The S & P 500 is selling at approximately 21 and 18.7 times our 2021 and 2022 earnings estimates respectively which is low in the current interest rate environment. We remain favorably inclined to stocks, industrial commodities, and gold especially with the Fed remaining all in providing excess liquidity until inflation is running above 2% for a sustained period which we do not see until sometime in 2023.  We continue to recommend the sale of all bonds.  Naturally, all of this assumes that we will have more effective therapeutics shortly, widespread quick response testing by the end of the year, and finally, several vaccines approved before year-ended with hundreds of millions of doses available for those most in need and more approvals by mid-year 2021 with billions of doses available or global distribution before the end of 2021.


News on the coronavirus continues to be very encouraging: the number of cases and deaths continue to decline; deaths are significantly reduced by the use of steroids; additional rapid response antigen tests are in production and will be distributed nationwide by the end of the year; at-home tests may be available before year-end, too; several vaccines have advanced with initial positive results, and the CDC has told states to get ready to distribute vaccines on November 1st.  Wow, that’s quite a bit of good news. Notwithstanding, we have not changed our view that it will take until 2022 for the economy to recover to pre-pandemic levels. However, it does mean that openings can be accelerated as rapid response tests become available nationwide by early next year. That is the real game changer!


The most recent economic stats confirm that our economy is improving at an accelerating rate as the number of cases and deaths have peaked: employment rose 1.37 million in August; the number of unemployed people fell by 2.8 million; the unemployment rate fell to 8.4%; hourly earnings rose 0.4%; the participation rate increased to 61.7; initial jobless claims fell to 881,000 in the week ended August 28th down from 1.01 million the prior week; continuing claims fell 765,000 to 13.1 million; the manufacturing PMI grew in August to 56 up 18 percentage points from July; the production index registered 63.3; the orders index 54.6; the employment index 46.4, an increase of 21 points from July;  and the services PMI  was 56.9. We all know how strong housing and autos are, too. All good and confirm an improving economy.


We hope that there is not a surge in cases in the fall which would slow the economy back down.  The Beige Book came out last week and confirmed that the economy recovered modestly over the summer but remained well below its pre-pandemic levels. The Fed remains very concerned and will remain overly accommodative for several more years. No surprises here and this supports our view that the Fed will continue to force investors further out on the risk curve.

The Presidential campaign is in full force and it is easy to see the differences between the candidates and their platforms. We are eager to listen to the debates before finalizing our decision but we are concerned about Biden’s economic policies which would impede growth, research and investment. Economic growth is a necessity to improve the quality of life while raising the standard of living for all.  We are also focusing on the need for law and order in this country. We are all for equality and peaceful protest but not unlawful rioting.


Investment Conclusions


While the new normal winners remain at the core of our portfolios, we have continued to shift, taking some profits, adding to companies that will benefit from faster opening with some more economic sensitivity. The game-changers will be quick response testing that will yield results in less than 10 minutes. While we remain concerned about more coronavirus outbreaks in the fall, we are confident that it can stay contained as long as people wear masks and adhere to social distancing. We also expect the death rate to continue to decline as better therapeutics are used along with improved medical techniques.


Finally, we expect consumer and business confidence to build as vaccines are approved and go into distribution throughout the world next year.


We look for sequential gains in economic activity, corporate profitability, and cash flow as we move through 2021 into 2022 above consensus. At the same time, we take the Fed at its word that it will continue to provide huge amounts of liquidity to the system until inflation stays above 2% for a sustained period which won’t occur until sometime in 2023.


The bottom line is that we remain favorably inclined to equities, industrial commodities, and gold. We would continue to avoid bonds. One of our core beliefs is to own the market/stocks at inflection points: when businesses turn up; operating margins improve, and earnings/free cash flow growth accelerates. Sounds like now.


It’s important to note that China has not kept the yuan from appreciating as the government has turned its attention to domestic consumption (cheap imports) rather than exporting production. That’s important as it may positively influence our trade relationship with China just as its fraying on other matters and it boosts our reported GNP.  A strong yuan helps Germany, Japan, and other countries that export big-time to China.


Finally, we see an acceleration in M & A activity financed with existing cash on balance sheets and/or by issuing new low-cost debt. Most, if not all, of these transactions, will be anti-dilutive except for the write-off of goodwill. This is another example where the big, well-financed companies have an advantage and will gain disproportionately in the new normal.


Successful investing is a process and a marathon. Stick to your core beliefs always challenging them but be willing to change if circumstances warrant them. We tend to be early uncovering new investable trends. And, if we must say so ourselves, our long-term record of success speaks for itself.


The next Investment Webinar will be held on Monday, September 7th at 8:30 am EST. You can join by entering into your browser or dialing +646 558 8656 and entering the password 9179217852.


Remember to review the facts; pause, reflect, and consider mindset shifts; look at your asset mix with risk controls; turn off your business news; do independent research and …


Invest Accordingly!


Bill Ehrman

Paix et Prospérité LLC


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