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Perspectives

Liquidity, Earnings and Sentiment (LES)

by Fortem Financial July 19, 2021

On July 9th we suggested that the bull market wasn’t over but that it was due for a breather due to already high expectations for earnings and market performance and the not insignificant chance that the yield on the 10-year Treasury note was telling us something. With the preannouncement ratio below 1, there remains little room for error during the reporting season. Today we present more evidence for this point of view with our regular monitoring of our LES Model. We developed the measure about 20 years ago to keep track of what we believe are the most basic building blocks of market health – Liquidity, Earnings, and Sentiment. The good news is that the first derivative of both Liquidity and Earnings continues to grow and grow rapidly. The bad news is that the second derivative is slowing. Particularly notable is the fact that M2 is “only” growing at 13.8% y/y. While that rate of growth is faster than what was seen at the 2009 low, it is slower than the 27% pace posted as recently as February. With inflation running hot, it should be noted that more of that liquidity is being siphoned off into the real economy, leaving less to fund financial assets. Earnings growth for the second quarter is likely to be up more than 70% y/y. Future earnings gains are expected for the 3rd and 4th quarters but at a much more modest rate of +26% and +18% respectively. Continued first derivative growth is nothing to be taken lightly from already-high starting points. The problems come when one considers sentiment and expectations for future returns. Valuations are rich by historical standards while the VIX and the Put/Call Ratios signal complacency. This is a bit worrisome to the extent to which individual investors are expecting a real return in 2021 approaching 13% according to Natixis. (Institutional investors are expecting a far more modest but healthy real return of 5%.) We believe the chance for a recession heading in 2022 is low and that the primary trend of the market remains bullish. Still, some consolidation of returns in the second half is probably a decent bet as the economy stabilizes.

First Week of 2nd Quarter Earnings Starts Strong

Last week was the first week of the second-quarter earnings season, and it got off to a strong start. The financial sector reported better than expected earnings, and although revenues improved from initial estimates, the beats were not as large. In aggregate, earnings are now expected to grow 72%, with revenues to grow 19.2%.

2022 Only Seeing Modest Adjustment Higher After First Week

While it’s still early and probably too soon to make any major conclusions, we are paying particularly close attention to 2022 earnings. As of now, they have only seen modest adjustments higher, but the pace of improvement continues to be less than 2021’s rise suggesting 2022 earnings growth is going to slow further.

Watching Margins Closely This Quarter

We’ve noted in the past that the market often does not get into too much trouble while margins are expanding, which is why we have paid so much attention to them as of late. The rise has been remarkable following the pandemic and eventually will slow. However, they may be beginning to happen now, leading us to believe this quarter will be a make or break for further margin expansion.

Strategist Estimates For 2022 Continue To Have An Upward Bias

With the latest strategist estimate data released on Friday, the bias remains to be toward the upside. Currently, the average among the 14 strategists with estimates available is $212 compared to an average of $204 back in April. Over the coming weeks, we would expect more strategists to update and or initiate on 2022.
Source: Strategas


Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments. Data provided by FactSet.

Sincerely,

Fortem Financial
(760) 206-8500
team@fortemfin.com

 

 

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