Aug 20, 2021 Equities

From drags to riches

Across much of the world, corporate earnings are doing surprisingly well. Alas, the market now appears priced for something close to perfection.

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Arguably, the biggest surprise of the year so far has neither been the swift economic recovery in the industrialized world, rising inflation nor seesawing U.S. Treasury yields. Even new strains of Covid-19 such as the Delta variant or the swift fall of Kabul to the Afghan Taliban following the withdrawal of Western troops cannot have come as a complete surprise to experts in those areas.

By contrast, very few were willing to bank on the strength of corporate profits we have seen in the year to date. Our Chart of the Week illustrates just how unusual the pattern in earnings expectations has been. In a typical year, there tends to be a little too much optimism around the New Year. Downward revisions follow and eventually, earnings expectations stabilize over the course of the year. During the past eight months, however, we have seen very different trends, with strong upward revisions for earnings in 2021, as well as forecasts for 2022 and 2023 rising sharply.

20210820_CotW_MSCI AC earnings_CHART_EN.png

* earnings per share (EPS)
Sources: Bloomberg Finance L.P., DWS Investment GmbH as of 8/17/21

So far at least, inflation and resulting cost pressures have not proven major stumbling blocks.

"As for delivery bottlenecks, our impression is that many companies were actually able to profit from this. By using limited production capacity to focus on their highest margin products, they in fact boosted their profitability,"

argues Thomas Bucher, Global Equity Strategist at DWS.

"Overall, corporate reporting has been so firm in recent months that analysts seem to be barely keeping up with upward revisions to their earnings estimates."

Moreover, as our chart shows, earnings strength has been a worldwide phenomenon. While especially pronounced in the U.S. and Europe, estimates for emerging markets have been rising, too. That said, many valuation measures are well above the long-term average, meaning it often takes more than an earnings beat to get a positive market reaction nowadays. Challenges also loom, from the proposed tax reforms in the U.S. and other industrialized countries aiming to collect more corporate taxes to China's crack-down on its tech champions. It remains far too early to say how long the current era of corporate riches is going to last. Analysts, after all, have a strong tendency to extrapolate from short-term trends too far into the future – which is one reason why their estimates tend to be so prone to revisions.

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