Earnings season arrives and guidance will be key Earnings season arrives and guidance will be key http://www.federatedinvestors.com/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedinvestors.com/daf\images\insights\article\growth-hands-holding-plant-small.jpg April 28 2021 April 7 2021

Earnings season arrives and guidance will be key

As 2022 comes into focus, room for upside remains but stock picking will be key.

Published April 7 2021
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The first-quarter earnings season that’s about to kickoff should prove interesting. Although investors as always will want to know how it went, the backward-looking Q1 actuals will matter most in the lockdown plays such as technology, software and health care that helped get the country through the pandemic. Disappointments in these areas will likely be hit hard. Partly due to rising yields if not sheer exhaustion in the momentum trade, the market’s locus has turned for now from these names and their promising long-term growth possibilities to the near-term acceleration that is likely in older companies whose revenue and earnings’ streams depend more directly on the economic cycle. For these stocks, the key focus in the upcoming earnings season will be less about the still depressed fundamentals of the winter season that has officially passed and more toward qualitative guidance for this year’s back half and 2022. In particular, our analysts at Federated Hermes are zeroed in on who appears to have the pricing power to pass through the rising input costs that many companies are now facing, and who doesn’t. A real winners and losers game is emerging.

On a broad macro level, as we said three weeks ago, we think 2022 economic forecasts are coming in too low, with most analysts expecting the 2021 fiscal stimulus sugar high to wear off and the economy to settle back to normal. We, on the other hand, think there are legs in the recovery given how far below trend we are—hospitality is just starting to reopen, and as it does, it should unleash a new level of demand for goods and services that heretofore tens of millions have been forced to do without. Manufacturing has a high multiplier, for sure, but services account for the bulk of our economy. Moreover, the global economy appears certain to rebound in stages, providing periodic rocket boosters to growth, as vaccine laggards catch up. Layered over all this: an ultra-dovish Fed that’s shown no inclination to raise rates and massive rounds of new fiscal stimulus set to come out of Washington late this year or early next.

To be sure, there are risks. Inflation will inevitably pickup due to near-term commodity—and soon skilled labor—shortages. We expect the global deflationary forces (digitization revolution, automation, global supply chains, etc.) that have kept prices under control eventually will reassert themselves. But if they do not and a new inflationary cycle develops, either the bond vigilantes will drive the 10-year Treasury yield above 2.5% and/or the Fed will initiate a policy reversal. Either would threaten financial assets. Tax policy and fiscal overspend are another worry. With the Dems holding very thin majorities in Congress, we’re assuming a more moderate course on both taxes and the next big spending bill will develop. But if the current plans go through, the market rally might be threatened.

At the end of the day, we see the positives outweighing the negatives and thus are maintaining our bullish stance and S&P 500 targets of 4,500 this year and 5,000 in 2022. We think the focus in the next few months will shift from the powerful, vaccine-fueled economic and earnings recovery that has begun and is almost baked into the cake for this year toward 2022, where our outlook is nearly as good as it is for 2021. Therefore, we are continuing to hold onto cyclical value stocks that some fear have already had their run. Some cyclical value names probably have. It’s not an “everyone’s a winner” market. As was the case last year as well, it’s a classic stock picker’s market, just this time around the set of winners will be different. In the earnings season ahead, we’ll begin to get a glimpse of whose got the pricing power to win this game, and who doesn’t. We’re ready.

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Value stocks may lag growth stocks in performance, particularly in late stages of a market advance.

Federated Global Investment Management Corp.