2020 Q4 earnings season has come to a close. In 2020, we saw earnings decline 12.8% in Q1, 30.6% in Q2, and 6.5% in Q3. The last time we saw growth rates this negative was in 2008-2009.
What may be forgotten as time goes on is how the 20Q1-20Q3 growth rates ended up much better than originally expected. For example, at the peak of the crisis, the 20Q2 and 20Q3 expected earnings growth rate at the beginning of earnings season was -43.0% and -21.4% respectively.
If we compare these expected growth rates vs. the actual growth rate, we see a dramatic improvement in growth expectations during the quarter. In 20Q2, we saw an improvement of 12.4 percentage points (ppts) from the start vs. end of earnings season. 20Q3 saw an improvement of 15.0 ppts.
Turning back to 20Q4, we saw a similar picture. In January, we wrote in our 20Q4 earnings preview post that the earnings surprise factor has been remarkably high compared to long-term averages. More specifically, over the past four quarters (19Q4-20Q3), the average earnings surprise factor has been 12.4% compared to a long-term surprise factor of 3.6%. We made a prediction that if we see similar levels in companies surprising to the upside in 20Q4, we could see the earnings growth rate improve from -10.3% at the start of earnings season to +2.4%.
It turned out that our forecast proved to be correct, for a couple of reasons. The first was that 79.3% of constituents reported earnings above expectations, well above the long-term average (since 1994) of 65%. Second, the 20Q4 earnings surprise factor is currently 15.8%. As a result, the 20Q4 earnings growth rate exceeded our original forecast of 2.4% and currently stands at 4.1%. Comparing -10.3% to +4.1% results in an improvement of 14.4 ppts. This ranks as the fourth largest improvement on record (dating back to 2002 Q3). We can see this data visually in Exhibit 1.
Exhibit 1: S&P 500 Growth Rates – Beginning vs. End of Earnings Season
Banks and FAAMG surprise to the upside
The quarter saw several inflection points in the dramatic u-turn in the 20Q4 earnings growth rate.
Banks kicked off earnings season with a flurry of positive earnings surprises, led by JPMorgan Chase, Goldman Sachs, Citigroup, Capital One, and Morgan Stanley. Looking at our I/B/E/S Key Performance Indicators (KPI), most banks saw a significant decline in loan loss provisions which helped drive strong earnings surprises. This KPI is defined as the expected amount put aside to account for future losses on customer loan defaults. Details are shown in Exhibit 2.
JPMorgan Chase released approximately $3.0 billion in reserves across wholesale and home lending during the quarter due to improving macroeconomic scenarios and higher expectations in the house price index.
However, CFO Jennifer Piepszak raised continued concerns about consumer debt: “in Card, we held reserves flat as we remain cautious about the near term, especially with the number of unemployed still nearly 2x pre-pandemic levels and potential payment shock coming to consumers from expiring benefits.” (Source: Refinitiv Eikon)
Exhibit 2: Loan Loss Provision for Highlighted Banks
FAAMG stocks as represented by Facebook, Apple, Amazon, Microsoft, and Alphabet also posted strong earnings surprises. Apple posted 20Q4 EPS of $1.68 vs. a consensus of $1.41, a difference of 19.0%. Microsoft posted a 23.7% earnings surprise ($2.03 vs. $1.64), while Amazon posted the largest absolute surprise of 94.8% ($14.09 vs. $7.23).
Mega-cap tech names have been selling off in recent weeks given a sharp rise in bond yields. The 10-year U.S. bond yield has risen from 0.91% to 1.5% since the beginning of the year.
Exhibit 3 highlights a novel way of looking at index concentration within the S&P 500 since 2012. FAAMG stocks now represent approximately 1/5 of the overall index. For comparison, FAAMG stocks have a 16.8% weight within the FTSE Russell 1000 index, which has increased from 6.1% in 2013. Exhibit 3 also highlights the shift in index composition by looking at the five largest stocks in 2000 which now only represent 8% of the index, compared to a peak weight of 17.3% in 2000.
Exhibit 3: FAAMG Weight within S&P 500
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While mega-tech stocks are candidates to sell off during a rotation into cyclical re-opening stocks, the earnings growth remains resilient. Aggregate FAAMG earnings growth in 20Q4 was 43.3%. This trend continues in 21Q1-21Q3 with expected aggregate growth rates of 46.5%, 29.3%, and 11.1% respectively. Earnings comparisons begin to get tougher in 21Q4 with an aggregate expected growth rate of -0.7%.
Looking ahead to 21Q1, S&P 500 earnings growth expectations have steadily increased over the last five months. The expected 21Q1 earnings growth rate is currently 22.3%, which has increased from 16.0% at the beginning of the year.
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