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Third-quarter earnings season is here and, normally, a short-term event like this – the bulk of S&P 500 earnings arrive in the span of a few weeks – isn't something clients obsess about it. Nor should they.
Still, as advisors well know, clients are becoming increasingly savvy and with easy access to a slew of information, and aware that earnings, broadly speaking, are on fire this year. What many clients may not know is that there are three primary drivers of total returns. In no particular order, those are dividends, earnings and multiple expansion.
“No question … company earnings have been impressive. The S&P 500 recorded the highest year-over-year earnings growth in over a decade in the second quarter. In fact, company earnings have been the key driver of index returns this year, accounting for the lion’s share of S&P 500 total return,” according to BlackRock research.
Here's the thing about S&P 500 earnings this year and it explains why this earnings season could be a cause of concern for some clients. Earnings are coming off a low base created in 2020 by the coronavirus pandemic. In fact, analysts covering industries that were really punished by the health crisis aren't even comparing this year's numbers to those posted in 2020. They're measuring 2021 against 2019 in search of more relevant comps.
Dealing with the Unusual
Indeed, this economic recovery is not straight from the pages of financial market history. The coronavirus bear market and recession for shallow by historical standards and the subsequent economic resurgence and earnings recovery are unprecedented.
The torrid pace currently being set by S&P 500 companies (and others) is exactly what some clients are concerned about. They're pondering for how long will this continue and when the good times subside, what the impact will be to their portfolios. That's where advisors come to extol the virtues of maintaining a level head and not getting paralyzed by data.
“A look at seven decades of historical data reveals market performance has not dropped off a cliff once economic growth and earnings slow,” adds BlackRock. “We looked at earnings patterns in years when real gross domestic product (GDP) growth exceeded 4%, and S&P 500 performance in the 12 months that followed. What did we find? The average index return in the ensuing year was a not-too-shabby 7%, based on a review of data back to 1948.”
Even when earnings and economic growth do slow – it's going to happen – there are avenues for surviving and thriving with equities. Many clients may not realize that, but that's why they have advisors and there's more advisors can do to help steady jittery clients when growth slows.
Focusing on Resilience
It's not an advisor's job to be a cheerleader for a particular asset class. Advisors should deliver facts to clients regarding what's working and what isn't.
That said, there's no denying equities are proving sturdy against the backdrops of a global health crisis and inflation. Stocks are proving resilient as evidenced by the degree to which companies are topping Wall Street revenue estimates.
“This suggests to us that even as inflation has been driving an increase in input costs, companies have the pricing power to offset it. They have been able to raise prices and push higher costs on to the end consumer, a reflection of pent-up demand and consumer willingness to pay. We’d expect cost pressures to abate in most areas of the economy as pandemic-dented supply rebuilds and demand normalizes,” adds BlackRock.
Look, earnings and economic growth are going to slow. It's inevitable, but advisors can win the day for clients by showing them that when those scenarios arrive, it doesn't mean stocks are going to crumble.
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