First quarter corporate earnings exceed expectations

The S&P 500 index was up slightly in the month of May due to growing investor confidence in higher 2021 corporate revenues and earnings. With the receding COVID pandemic, consumers and businesses are emerging from social-distancing protocols and accelerating their spending. This strong growth in demand for goods has led to inventory shortages in many cases. Temporary delivery delays for raw materials and components are constraining global growth. Employment is expanding, however, which means goods manufacturing should improve and service industries should gain momentum.

With energy, food and home construction costs rising significantly over the past two quarters, investors are getting concerned. The Federal Reserve has adamantly assured the markets that this inflation is “transitory and temporary” and they infer they will not raise interest rates this year. The bond market seems to believe this because the 10-year U.S. Treasury bond is yielding 1.62%, while the consumer price index is rising at 4.2%.

Corporate earnings generally exceeded expectations in the first quarter and may again surpass estimates in the second quarter as GDP growth jumps to as much as 7%. The largest earnings increases came from energy, financial and basic materials companies, and these sectors have performed the best so far this year. Small cap and mid cap stocks are still outperforming, with value stocks generally rising more than growth stocks. Developed European stocks, which have been dormant underperformers for years, are beginning to emerge from a long period of stagnation. Most Asian markets, like Japan and China, are underperforming the U.S. this year.

China is beginning to confront its large non-performing loan issues in their banking system. China Huarong, a large bank, distressed loan manager, and state-owned-enterprise, was recently unable to meet an interest payment on its debt, some of which is dollar-denominated. A state-owned-enterprise default is unlikely, however, because international bondholders would avoid buying any more Chinese financial-issued bonds, making China’s financial problem even worse. It will be interesting to see how this issue is resolved, because many of China’s bank loans are classified as non-performing.

The Federal Reserve’s accommodative monetary policy is providing massive cash balances at banking institutions. Much of this is earning little interest in Demand Deposit or Money Market Accounts and these investable funds will provide more fuel for the financial markets. In addition, the Biden Administration’s multi-trillion-dollar infrastructure spending program is expected to provide even more long-term economic stimulus. These two major factors provide a constructive outlook for the equity market to continue to rise this year.

Index Performance Year-to-Date

• S&P 500 Index 11.9%
• Russell 200 Index 14.9%
• MSCI AWCI International 10.0%
  
  

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