October performance was strong. By month’s end, most US broad equity benchmarks had touched new all-time highs more than once with the exception of indexes tracking small capitalization and small value companies. International and Emerging Market issues were also firmer but have not been able to match domestic performance, so far.
Interest rates have been mixed since the end of the third quarter with most of the action in shorter maturities, as we have discussed in recent posts. While inflation continues at a roughly 5% year to year increase through the most recent statistical reports, yields in the Treasury market do not yet in corporate expectations commensurate with current levels.
Markets have been trending still higher in the early days of November, supported by strong earnings reports from a variety of industries and market sectors. Performance of key global benchmarks through October 31 is below.
In the long run, corporate earnings provide the rationale for market and individual issue valuations. Investors expect returns on an investment initiated today, over time, to be positive, which is why they invest. Short term events can and do influence immediate market action but the prospect of future increases in per share profits and revenues are the foundation of equity prices.
The third quarter of 2021 is delivering another blowout earnings season, carrying on with the positive year to year comparisons that began earlier this year. Strong consumer demand as more of the global economy reopens has produced record profits but has also prompted sharp domestic wage increases as companies in a variety of industries struggle to find workers willing to return to work.
Through November 5th, of the 89% of S&P 500 constituent companies that have posted third quarter earnings, 81% have beaten EPS estimates. In aggregate, earnings are roughly 10.3% above projections. With roughly 10%of S&P 500 constituents still to report the growth rate for earnings compared to Q3 2020 is currently better than 39%, which if it holds, will be the strongest YTY performance since Q2 2010.1
Top line results have also been better than expected. In reports already released, revenues have topped estimates for 75% of reporting companies with an aggregate growth, so far, of 2.9%. If this rate is sustained through the balance of reporting, the annual revenue expansion will be the greatest since2008.2
So, there is no mystery surrounding the now 5-week general advance by domestic equities. In fact, what has occurred has been almost a price “melt up” with myriad positive surprises occurring across the corporate landscape. The chart below details how estimates as of September 30th have been overtaken by actual results in all but one sector, through November 5th.
Last week produced several important news items. On the monetary front, the Federal Reserve has now confirmed that next month it will begin cutting back on its monthly bond and mortgage securities purchases. The tapering process is expected to last until Spring 2022.
Mr. Chairman Powell, to date, has not been renominated for a second term. Progressive senators such as Elizabeth Warren (D-MA) have made abundantly clear new Fed leadership is desired, but the White House has remained non-committal about the identity of the next Fed Chairman.
On Tuesday, November 2nd, voters in Virginia and to a lesser extent New Jersey, delivered a message of dissatisfaction with policies represented by the Democrat candidates for Governor in those states.
Mr. McAuliffe’s defeat in Virginia was attributed to a strong reversal of support in solidly Democrat areas, predicated, based on exit polls, on economic issues, i.e., inflation, and to a smaller but still significant level, on parents’ desire to retain a role in determining the educational curriculum for elementary and secondary school students.3
Mr. McAuliffe attempted to make the election a referendum on national events and trends and lost. His opponent concentrated on so-called kitchen table issues: local control of education, rising prices for essentials, and repeal of certain state taxes. The result was Republican victory in a state that had given President Biden a 10% margin in 2020.
For Virginia, the election was an earthquake. But in our view, a localized earthquake. Pundits on the right have interpolated the outcome as foreshadowing a “red-wave” but November 2022 is multiple lifetimes away in political terms. It would be a mistake for Republicans to consider last week’s results as the precursor to a guaranteed change of control in Congress next year.
Virginia voters expressed disapproval of the status quo, but the next election is far in the distance in a world of 24 hour news cycles. The US economy remains in recovery mode with corporate earnings strong and employment resuming expansion after September’s expiration of supplemental unemployment benefits, confirmed by the far better than projected October Unemployment report on November 5th.
As expected, Democrats were not willing to let the Senate passed infrastructure funding lie unspent. The bi-partisan bill was approved by the House this past weekend and Mrs. Pelosi has again promised a vote on President Biden’s Build Back Better (BBB) bill before the Thanksgiving Congressional recess.
Progressive Democrats, who have been the driving force behind in Congress, seem unconcerned by voters’ verdicts. In fact, Speaker Pelosi has now added back programs and spending that had been removed from the BBB legislation, abandoning an effort to appease Senators Manchin (D-WV) and Sinema (D-AZ).4
House Progressives appear to have adopted an almost nihilistic attitude toward the remainder of this Congress. Statements from the Speaker and others suggest the mindset is, “Damn the torpedoes, full speed ahead!” It appears they intend to leverage their slim majority in the House to enact whatever can be enacted before the 2022 mid-terms, which could conceivably mark an end to Democrats’ full legislative control.
Political dynamics will change after year end as the mid-term elections begin to draw attention away from Washington DC, but in the immediate future, expect more attempts by the majority to pass the President’s flagship bill.
Markets are currently focused on earnings but ahead lie a potential leadership change at the Fed, reduction of bond and mortgage backed security purchases by the central bank, no imminent action to counter steadily increasing inflation and in all likelihood, material increases in interest rates as the Fed attempts to “normalize” the rate climate. For now, however,“steady” is a good word to describe the capital markets.
1 "S&P 500 Earnings Season Update: November 5, 2021,”www.insight.factset.com, November 5, 2021. 2Ibid. 3 “Exit poll results from the 2021 election for Virginia governor, ”www.washingtonpost.com, November 3, 2021. 4 “Pelosi Adds Back Paid Leave and Increased Salt Deduction to Build BackBetter Bill,” www.thomsonreuters.com, November 4, 2021.
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