May 2021 | Mid-Quarter Update

As we approach the middle of the second quarter there is plenty of economic and financial market news worthy of comment, but the biggest story is the dramatic improvement occurring across the economy and the very favorable response from corporate America with its earnings progress. We believe it is becoming increasingly apparent that the U.S. economy will experience a boom this year. We don’t use the word “boom” casually, but it appears appropriate for current conditions. Furthermore, the same label can be applied to the performance of corporate earnings. The stock market has taken notice of this good news and has been unrelenting in its move upward since the end of March last year. The market has been up in 10 of the last 13 months, a far greater than average percentage of up months. The economy is now recovering faster than expected, and companies are doing better than expected in that environment. We think this is a powerful combination.

To give some color to the picture, we note that for the first quarter of this year, Gross Domestic Product (GDP) came in at an annual rate of 6.4%, or just over 2% for the quarter. Keep in mind that over the last 10 years the economy has been able to grow at only 2% per year. Other economic series are confirming the same trend, including manufacturing, confidence, and retail sales. The economy is being powered by the tailwinds of massive monetary and fiscal support, over $2 trillion of excess personal savings that have been built up over the last year when consumers were receiving government checks that they could not spend due to shutdowns, and an economy that is fast reopening as infections fade and vaccines are in ample supply.

Within this favorable economic environment, companies are doing even better by comparison. Some 70% of all companies have reported earnings for the first quarter of this year, and the results are startlingly good. Of those that have reported, 86% have delivered results that were above consensus expectations. In the aggregate, companies are beating expectations by 23%. This momentum is flowing into earnings estimates for all of 2021, which are now expected to be up by 32%. Importantly, earnings estimates for 2022 are also strong.

If one wishes to quibble with the earnings progress, there are a couple of factors that might be considered. The five largest technology companies now comprise 25% of the S&P 500, and their earnings comparisons are dramatically higher than the average. Thus, the overall earnings less the five technology stalwarts is not quite as impressive. And banks, another strong performing sector, are releasing loan loss reserves established last year, thereby inflating their earnings. We believe it is a good sign that banks are willing to release bad loan reserves, but earnings coming from loan growth would be considered of higher quality. While these two factors slightly diminish enthusiasm for the earnings season, we think they are minor compared to overall strength in the corporate earnings picture.

Lest our message be construed as one-sided, we note several areas of concern as investors contemplate the overall environment. Inflation is a hot topic. Many expect the strong economic performance coupled with continuing aggressive monetary and fiscal efforts will inevitably lead to an inflation problem. These concerns are yet to be realized, although it is widely expected that the inflation measures will be ticking up in the months ahead due to base comparisons. We still favor the position that these increases are likely to be transitory and that, as the economy gravitates back toward a more normal position, inflation pressures will recede. We shall see. Certainly, we will be keeping an eye out for signs of sustained inflation. There is also the concern among some that corporate earnings are so strong that they may be peaking. The question is, what can companies do for an encore when recent results have been so strong? Finally, we acknowledge that, by most valuation measures, stocks are not cheap. In our view, high valuations are less likely to presage a bear market in stocks than they are to limit future returns. In other words, we may be borrowing from future returns in stocks by enjoying such strong markets now. We believe it is usually best to maintain reasonable expectations looking forward.

As is almost always the case, we believe one must balance the positives and negatives in the economic and investing environment. As for stocks, we remain committed to their ability to provide satisfactory returns over the long term, especially those that fall in the quality realm.

Crawford Investment Counsel Inc. (“Crawford”) is an independent investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about Crawford including our investment strategies and objectives can be found in our ADV Part 2, which is available upon request.

This material is distributed for informational purposes only. The opinions expressed are those of Crawford. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass.

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