This week, CIO Tom Weary, CFA®️, shares positive news on total fourth-quarter and full-year earnings. He also touches on the American Rescue Plan, recently signed into law, before discussing a few possible reasons to remain cautious, including rising interest rates and an oversupply of publicly traded companies. Finally, Tom shares the latest earnings from RFA Defensive Portfolio holding Oracle Corporation.


Hi, I’m Tom Weary here at Reilly Financial Advisors with your Weekly Market Update.  Recent news on the pandemic, the economy and corporate profits has been looking up recently, so I am feeling cautiously optimistic.  We’ll get to an earnings report from Oracle in a moment, but first let’s start by taking a look at the case for optimism before examining some of the grounds for caution.

With earnings season now essentially over, there are grounds for optimism.  For starters, earnings looked really good in the fourth quarter. Total fourth quarter earnings for 482 of the S&P 500 companies were up 3.5% year-over-year on 2.9% revenue growth, with 80% beating earnings per share estimates and 76% beating revenue estimates. Think about this earnings comparison for a minute.  In the final quarter of 2019 there was no pandemic, and the economy was strong by nearly every measure. Yet even with all of the pandemic-induced destruction, S&P 500 companies still managed to grow year-over-year in final quarter of 2020. Pretty remarkable.  What’s more, 80% represents an above-average proportion of companies beating consensus estimates, and guidance has been positive as well. This favorable guidance has been helping push estimates for the current and coming quarters higher – all good signs. Full-year 2021 earnings for the S&P 500 are expected to be up 28% relative to 2020 estimates. In short, earnings season has been very supportive of the ‘economic resurgence’ narrative, and it is certainly a bullish sign.  Monetary and fiscal policy drivers remain in full accommodative mode. The Federal Reserve used its January meeting to assure investors they will remain in support mode until the labor market shows significant improvement, which is likely to take at least this year but probably longer. The fed funds rate will not move in 2021, and the bond purchase program won’t be tapered without ample warning.  On the fiscal side, the Congress has passed the $1.9 trillion American Rescue Plan, which includes another $1,400 in direct stimulus payments, an additional $1,000 child tax credit, and an extension of unemployment benefits to August 29. The sheer size of the bill and the inclusion of direct transfer payments only add to the already massive amounts of liquidity sloshing around in the capital markets.

Are there reasons to be cautious?  Let’s focus on three areas: interest rates, too much investor optimism, and over-supply.  One of the reasons the stock market has been comfortable trading at such a high multiple is the understanding that interest rates would remain “lower for longer.” We know the Federal Reserve is likely to keep short rates anchored to the zero bound, but longer-dated U.S. Treasuries have been marching steadily higher over the last year.  As interest rates go up, the “risk premium” – which is the spread between the risk-free rate on Treasuries and the yield on the S&P 500 – shrinks. A narrowing risk premium could mean trouble for high valuation stocks.  The next cause for caution is investor optimism, or specifically, too much of it.  You are probably aware of the retail trading mania going on, with get-rich-quick storylines popping up every day, mostly on the internet. It’s also true that individual investors opened more than 10 million new brokerage accounts in 2020, which was a record, and margin balances have been steadily rising. Too much optimism is usually bad news for stocks, and I’m cautious about investor sentiment creeping towards euphoria.  Finally, there’s the over-supply issue. The number of publicly-traded companies is on the rise after a 20 year slump. From 1997 to 2017, the number of listed companies dropped from 8,500 to 4,500, spurred by the tech bubble bursting. The tide has been shifting. After modest upticks in 2018 and 2019, the number of listed companies surged by 200 in 2020, and investors expect 2021 to post even bigger increases. “SPACs” are all the rage on Wall Street, as an increasing number of often risky start-ups seem eager to raise capital and eschew the regulatory requirements associated with IPOs. When companies are clamoring to issue shares in a hot market, I think that’s generally a foreboding trend.

After the close on Wednesday, Defensive Portfolio holding Oracle reported results that beat on the top and bottom lines with sales of $10.1 billion increasing 3% from last year and beating estimates by $20 million leading to earnings of $1.16 per share up from 97 cents a year ago and beating by a nickel.  With robust margins of 47%, operating income increased 10% from last year to $4.8 billion.  Oracle gets 72% of their revenues from highly reliable enterprise software subscriptions, leading to steady results.  With a growing presence in cloud computing, Oracle is viewed by some as a less expensive way to have exposure to the area without paying high prices for the leading players.  Some analysts were hoping for even greater growth in cloud computing revenues, but I was pleased to see the company increase their dividend by 33%.

So, what does it all mean?  Things are looking up for public health, the economy and corporate profits.  But is most or all of the good news already baked into stock prices?  There are grounds for both optimism and caution.  As always, I try to remain devoutly agnostic.  Our mission is to build for you all-weather portfolios of the highest quality companies that beat their peers in the good times and transform themselves in the challenging times.  That mission doesn’t change because of the current climate.  So, please, sit back, relax, and join us again next week for the RFA Weekly Market Update.

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