Three-minute macro: what’s driving earnings?

The last two years of equity markets were driven by price-to-earnings (P/E) multiple expansion, but heading into 2021, our view was that equity market performance would be driven by earnings instead. The modest S&P 500 Index returns in 2021 so far have been driven by forward earnings per share (EPS) revisions, rather than forward P/E changes as we saw last year. With over 90% of S&P 500 Index names trading above their 200-day moving average, breadth has certainly improved within the equity markets. We view this as positive given that the index isn’t being held up by specific segments, but we also believe this increases the importance of earnings as most companies have recovered substantially since their lows.

After the significant earnings beats for 2020 full-year results, we’ve seen plenty of upward earnings revisions, especially for the second quarter of 2021. We suspect this a function of both base effects (i.e., the very weak results of the second quarter of 2020) and the faster-than-expected vaccine rollout in the United States, which is accelerating the reopening. During Q1 earnings season, we expect markets to be sensitive to corporates results as they digest how the reopening is panning out against lofty expectations and already-rich valuations. Simply put, corporates will finally have to prove that they’re worthy of Wall Street’s optimistic expectations.

Source: Manulife Investment Management, Bloomberg, as of April 5, 2021. 

One of the pandemic’s darling sectors has been residential real estate. In particular, the U.S. housing market has surged on the back of low interest rates, favorable demographic factors, weaker supply, and nesting habits brought on by the pandemic. As of February, total home sales were up 23% year over year,¹ while the ~1.9 million permits issued in January were roughly in line with the low end of the range seen in the real estate boom during the mid-2000s.

While we maintain that overall activity remains healthy, there are a couple of factors that suggest a potential cooling off during the second half of the year. Most fundamentally, changes in mortgage rates matter, with about a 4- to 6-month lag. While rates are still below where they were a year ago, the tailwind that we’ve experienced for the last 11 months has also started to fade and could weigh on activity around the beginning of the summer. The National Association of Home Builders (NAHB) survey is to some extent related to interest rates; it has started to moderate and would signal that the surge in permits and starts could subside. Finally, while we’re all looking forward to getting back to normal life, it could also beget a reversal of that nesting impulse as people benefit from improved mobility. This could improve supply on the existing home sales market and diminish any urgency to improve living situations, which, at the margin, could contribute to a cooler market.

Source: Manulife Investment Management, National Association of Home Builders, U.S. Census Bureau, Macrobond, as of March 18, 2021.

We get a lot of questions about the “S” in environmental, social, and governance (ESG) investing. From a macro perspective, three areas of focus in this realm that are increasingly relevant to our outlook are the discrepancy between the male and female labor force participation rates (gender inequality), the U.S. Federal Reserve’s (Fed’s) focus on BIPOC employment (racial inequality), and redistributive elements of fiscal policy (income inequality).

Regarding gender inequality, we note the positive impact to both growth and corporate earnings in countries in which an increase in the female labor force participation rates is plausible. Levers that have been used to address this disparity in other countries have frequently included more supportive childcare policies, allowing women to reenter the labor force more quickly after having children. The U.S. female labor force participation rate remains dramatically lower than that of males, and gains in the second half of the 20^th century have plateaued since then.

We also note the importance that income inequality is playing in President Biden’s proposed US$2 trillion infrastructure plan and policy agenda, which aims to combat this inequality through tax increases—we believe these changes will be a cornerstone of upcoming fiscal policy. Finally, Fed Chair Jerome Powell has made several comments in the past year regarding racial inequality and has indicated that the Fed will be doing its part to combat this. We’re also seeing many large corporations step up with diversity and inclusion efforts.

We’ve said it countless times, but it bears repeating: We’re convinced that social issues will increasingly be an area of focus for major financial institutions, and we think that the aforementioned changes are just the tip of the iceberg. 

Female labor force gains have plateaued
U.S. labor force participation rates

Source: Manulife Investment Management, Bloomberg, Macrobond, as of March 18, 2021. 

1 National Association of Realtors, U.S. Census Bureau.