Gravity-defying market finds rationale in bullish profit views

A stock market sustained by little more than hope all year is getting evidence 2021 will bring more tangible support, lifting it above an assortment of dramas.

Optimism is being fueled by developments that, while occurring largely out of sight, form an increasingly durable bull case for equities, particularly with respect to a corporate recovery in 2021. While Federal Reserve stimulus, vaccines and small-investor enthusiasm remain central to the picture, signs of strength in next year's profit outlook are now perhaps a larger factor putting a floor under equities.

They help explain the market's buoyancy in recent weeks when spiralling virus rates and squabbling over government aid to the economy and Brexit have done little to dent a 13% advance in the S&P 500 since October.

Behind the resilience are steadily improving forecasts for 2021 earnings, which analysts have now raised in 10 consecutive weeks. Among S&P 500 companies issuing profit guidance for the fourth quarter, more than half have increased it, the most in at least a decade, data compiled by Bloomberg Intelligence show. Investors are reacting, bidding up virtually any company whose results are poised to hold up.

"There's an overwhelming consensus in both the stock and the bond markets that we can take the risk of looking through the dark winter to a stronger economy and stronger earnings as 2021 progresses," said David Donabedian, a chief investment officer of CIBC Private Wealth Management.

Among companies, Paychex Inc upped its guidance this week, while last week homebuilder Lennar said 2021 results will be better than expected. Supermarket operator Kroger Co boosted its same-store sales for next year earlier this month. And data company Fiserv earlier this month gave a medium-term growth outlook that topped Wall Street's estimates.

The S&P 500 was down 0.2% in the holiday-shortened trading week as of 1 pm in New York. Still, the benchmark sits within 1% of a record. Meanwhile, the Russell 2000 small-cap index notched an eighth straight week of gains, the longest streak since February 2019. US equity markets closed at 1 pm Thursday and will be shuttered Christmas Day.

While improving Wall Street forecasts and guidance guarantee nothing for 2021, they are the most concrete sign of progress out of this year's economic morass, and development investors have counted on since March when the S&P 500 began a 65% rally. Among other things, getting near the targets is needed to normalize the stock market's valuation, which based on this year's results sits at the highest since the waning days of the dot-com bubble.

Profits for S&P 500 companies are now expected to top $167 a share next year, according to the bottom-up consensus of Wall Street researchers. That's the most optimistic view since April when analysts were ratcheting down forecasts due to the unknown effects of Covid-19. The current estimate is up from $159 a share in July, a 5% increase.

"We need earnings to be strong. Different than what we normally see, we're seeing expectations going higher for earnings," Victoria Fernandez, chief market strategist for Crossmark Global Investments, said in an interview on Bloomberg Television. "Normally you see companies start to lower those expectations, and they're actually moving higher, which is good."

At its current level, the S&P 500 is about 22 times projected for next year's earnings -- still high, but down from 29 times forecasts for this year.

A look at 10 company characteristics or investment style factors tracked by Bloomberg shows the biggest gainers this month are tied to a brightening earnings outlook. Variability and profitability, two of the best-performing styles in December, are both connected to companies' earnings outlooks, the former measuring consistency of results and the latter how profitable a company has been. Its strength was cited by Ned Davis Research, which recommends that clients invest in firms where analysts' earnings expectations for the next 12 months have jumped the most.

How badly investors are counting on companies to deliver next year can be seen in measures of investor sentiment. A gauge compiled by Citigroup that tracks metrics from margin debt to options trading and newsletter bullishness shows levels of "euphoria" among stock bulls at all-time highs. Call option activity is near a record and the S&P's 14-day relative strength index is inching closer to an overbought zone. It doesn't help that Donald Trump threw a wrench in the optimism over the stimulus package, casting doubt on whether he would sign off on the bill due to the size of stimulus checks.

"Vulnerabilities are in place even as few clients are willing to miss out on the upside with fear of meaningfully underperforming winning out," said Tobias Levkovich, Citigroup's chief US equity strategist. "Vaccines illuminate the path to normalisation but, one needs to get through a harsh winter first."

Disclaimer: This opinion first appeared on Bloomberg, and is published by special syndication arrangement