3. Can the winners keep carrying us? The Russell 1000 Growth Index is expected to grow earnings 6% year over year in the fourth quarter, compared to the 12% decline expected for the Russell 1000 Value Index. If earnings growth is to resume broadly, we need stronger earnings growth from growth-style stocks—many of which are so-called “stay-at-home” stocks in the technology and internet areas—and some help from the economically sensitive value-style stocks that have struggled during the pandemic.
4. Will cost pressures show up in profit margins? It may be too soon to worry about this, but the latest rise in interest rates and commodity prices may influence the profit margin assumptions management teams make when sharing their earnings outlooks. Operating margins have come down a couple of percentage points during the pandemic, and companies may struggle to push them higher in the first quarter as the pandemic lingers.
Strong Earnings Ramp Ahead
Perhaps the most important element of this earnings season is whether company management teams can instill confidence in the strong earnings rebound baked into analysts’ forecasts. This becomes particularly important for a stock market that is trading at elevated valuations and keying on profits in 2022 and beyond during this challenging and unprecedented economic environment.
Despite lingering effects of COVID-19, in 2021 we expect the economic recovery—in the United States and internationally—to drive a big rebound in corporate profits. Boosted by cost efficiencies achieved during the pandemic we potentially could see S&P 500 earnings growth of 25% in 2021. Our forecast for S&P 500 EPS in 2021 is $165, slightly above 2019 pre-pandemic levels.
As the threat of COVID-19 diminishes and the economy moves toward fully reopening, we anticipate corporate America will begin to showcase its much-improved earnings potential. Up to $190 per share in S&P 500 earnings could be possible in 2022, a 15% increase from our 2021 estimate. A potential increase in the corporate tax rate in 2022 under a Democratic-controlled Congress introduces risk to this estimate.
Reiterating LPL Research’s Positive Stock Market Outlook
We see an S&P 500 Index fair value target range of 3,850–3,900 at year-end 2021, with potential for upside if there’s better-than-expected progress on vaccine distribution and additional stimulus. A strong earnings rebound may enable stocks to grow into somewhat elevated valuations. Meanwhile, the ongoing pandemic presents lingering risk in the near term. Our S&P 500 target is based on a price-to-earnings (PE) multiple slightly above 20 and our preliminary 2022 earnings forecast of $190.
Jeffrey Buchbinder, CFA, is an equity strategist at LPL Financial. Ryan Detrick, CMT, is chief market strategist at LPL Financial.