Earnings season has been great until now with maintaining profit margins up in the face of inflation

Merchants work on the floor of the New York Stock Exchange (NYSE), July 21, 2021.

Brendan McDermid | Reuters

A quarter of the way through earnings season, we head to the best profit growth in over a decade.

A quarter of the S&P 500 has reported now second-quarter earnings. Overall earnings now they should grow by 76% year-over-year for the period, according to Refinitiv, the best growth Since 2009.

Why are stock prices still close? record levels?

Still, the trading community he was well aware that Q2 was going to be a historian quarter, probably the “peak” of earnings growth. The S&P 500 continued to fluctuate just shy of record tall for other reasons:

Estimates continue to rise for the third and fourth quarter. While the rate of growth for earnings it’s slowing down, they’re still growing. Third quarter earnings I’m currently planned rise 27% for the same period last year, up from 20% on April 1st.

Fourth quarter earnings expected rise to almost 20%, up from 13% on April 1st.

Profit margins hold up. Other than consistent earnings growth, nothing is more important for fundamental investors with respect to profit margins – the percentage of sales that transform in profits. The trading community he was terrified of relationships of exorbitant increases in the cost of raw materials, And of Very higher wages in some sectors (in especially the services), all of them of which could severely erode margins.

Until now, with few exceptions, the fear was not justified. While the margins for the S&P 500 was generally between 9% and 11% range for the past five years, the first quarter saw margins at 13.0%, a historic one record. According to quarter it currently sees margins at 12.8%, according to S&P Global.

Why do margins hold? up so well? While companies report higher the costs are offset by the prices power.

“While the advantage of NOL [operating leverage] is definitely fading and inability to pass on rising the input costs are a risk for a short list of company S & P500, in aggregate net income margins should remain well supported and cost should be offset by the price power And operating leverage, “Dubravko Lakos-Bujas, chief US equity strategist for JPMorgan said in a recent note to customers.

“Families are well positioned to absorb rising costs given the high savings of households and the strong workforce market,” he added.

Operating leverage is providing further earnings growth. Last year, companies drastically reduce costs by reducing travel, cutting down on real real estate expenses, e cutting jobs. As revenues started to improve, more of those additional revenues go to the bottom line, e effect known as operating influence.

Despite the effect of the pandemic on profits in in early 2020, Nicholas Colas, who analyses market trends like head of DataTrek, note that this is the culmination of two extraordinary years of growth: “In the 2 years since Q2 2019, the S&P 500 generated 17 percent earnings growth on 3 percent income growth… This resists in stark contrast to the 2011-2019 period, when earnings has grown a lot more slowly.”

Covid variants don’t derail the recovery. A more recent source of the concern was the emergence of more contagious variants of covid, which has created considerable confusion on how Very protection vaccines would provide those who are vaccinated, and the extent in which there can be new regional blocks in late summer and autumn, in particular in regions with low vaccination rates.

So far, the CEO’s comment has generally been muted.

“We didn’t see any impact from the variants,” Delta CEO Ed Bastian said on Our air on the day in they reported earnings. “When we track our reservations we have enough good visibility from 60 to 90 days out… we haven’t seen a slowdown or a downtick in reservations “.

It is early in earnings season, so the CEO’s comment may change more caution if hospitalizations increase dramatically.

For the moment, the market he is running with the narrative that variants can slow down the recovery, but don’t derail it.

Did the markets dodge yet another bullet?

So far, the second quarter the strong upward trend that characterized the market for the last several quarters.

“This change in marginal profitability is a key reason great of the United States caps remain resilient, “Colas said.” We’re still a little wary around term due to seasonal volatility patterns, but 2019-2021 step up in marginal profitability maintains us solidly bullish for longer term. “

Lakos-Bujas by JP Morgan also remains bullish: “Overall above 10% earnings surprises and positive indications on revenue and margin estimates this earnings season should help dismiss some perceived fears around the stall growth momentum, above all in forward of what should be a record setting back-at school e holiday season in the United States.”

What could go? wrong?

While earnings the estimates are still rising, the rate of change is slowing down. “Last earnings season, analyst the estimates were in kind rising 5% after company reports “, Nick Raich, who analyzes corporate profits at Earnings Scout, he told me. “This quarter, they are rising 3%. “

Historically, Raich says, which implies the multiple on the S&P 500 (the price investors are willing to pay for $ 1 of earnings) should start to contract. The multiple expands when the expected profitability expands and contracts when it weakens.

But Raich believes it is still too early to do so call: “We think stock prices will continue to rise higher in year fine, as long as the estimates hold rising. “

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