The S&P 500 is near its all-time closing high despite COVID-19, job losses, and a severe, brief recession. There are several contributing factors that may be transitory in nature. Easy monetary policies at home and abroad have helped stabilize financial asset prices and provided an impetus for people to move into risky assets. Low interest rates have contributed to a search for yield in riskier assets while making them look relatively more attractive. Finally, running a large fiscal deficit has helped to support the economy as we move through the pandemic.
However, notall the gains are due to monetary and fiscal policy. COVID-19 has made large and small businesses reexamine how they do business and has led to an acceleration in productivity-enhancing technology investments. Working from home has led to productivity improvements for many white-collar jobs. Consumers have become more comfortable placing orders online. This has led to profit margin improvements for retailers that have invested in direct-to-consumer sales infrastructure. Restaurants have reduced their menu and reduced food spoilage while people worry about dining out at restaurants. The trend in business process reinvention has been seen in large and small businesses alike. Business formations have shot up after being stagnant for two decades. A quick and rapid economic recovery has seen nominal GDP reach an all-time high after the COVID-19 shutdown.
Productivity growth is hard to measure and forecasting it may seem like a trivial exercise. Nevertheless, it is vital in driving economic growth and profits. The two main determinants of economic growth are demographics and productivity. The positive effects of an expanding workforce have been waning for a while as birthrates and immigration decline. Productivity growth has been on a downward slope for decades. All else being equal, growing productivity can reduce budget deficits and raise the standard of living. Productivity increases can grow the economy and lead to higher output, wages, and profits.
Corporate profits are at an all-time high and our guess is that they will continue to grow. We believe most of the gains look sustainable and the economy is not fully reopened yet as parts of the service sector are still operating below capacity. There are currently more jobs available than there are seekers according to the Bureau of Labor and Statistics. S&P 500 earnings are now above the 2019 year-end level despite the COVID-19 disruption and even with leisure industries still operating well below prior peak levels. Trailing four-quarter earnings are now at an all-time high at around $164 (see chart).
Current projections for 2021 earnings are around $200 while 2022 earnings are estimated to be around $219 according to Bloomberg’s aggregation of analysts’ estimates. NPP does not think these estimates are overly optimistic. The current earnings power of the S&P 500 is probably close to $200 before any economic improvement. Some of the recent equity gains may be a case of too much too fast. The market has gone close to a year without a meaningful pullback and may be a bit ahead of itself and due for a pause. We are entering a time of the year where pullbacks often occur. Yet we still feel profit growth is strong enough that any correction should be seen as a buying opportunity.