April 12, 2021
The profit outlook going into CQ1 earnings season is highly supportive for the broad equity market. There’s been some concern around last week’s higher PPI number, but the historical correlation between PPI and profits has always been positive. Profit margins are improving as the acceleration in activity drives volumes and operating leverage. Consensus expectations for Q1 SPX earnings growth is running at 24.5%. Expectations for Q1 cyclical sector earnings (that includes the 3 value sectors) are still 16% below pre-pandemic levels and, therefore offer the greatest upside. The first week of earnings season is always heavily weighted toward banks. We did this Friday, but expect another low-quality beat this quarter from US large cap banks driven by accelerating reserve releases, while loan demand shouldn’t see a pick up until H2. And any small improvement in Net Interest Margins (NIMs) probably won’t flow into earnings yet. We’re not huge fans of large cap banks but expect investors will ‘look across the valley’ and stay long the group. Our preference for Financial sector exposure remains in regional banks that still trade at 1.3x out-year Tangible Book Value vs. an historical average of 2x and pre-pandemic levels of 1.9x.