Powerful corporate profits and forecasts of more to come have investors cheering

Blowout earnings are forcing analysts to up estimates for 2021.

With a little more than half of companies reporting, earnings are proving to be a pleasant surprise for the trading community.

The GameStop/Robinhood fiasco is turning out to be a minor blip in the markets in the first weeks of 2021. The main theme that ended 2020 — the belief in the effectiveness of a vaccine — remains intact.

"The markets are advancing to new highs as Covid cases are dropping, stimulus is coming in at the higher end of expectations, and we are continuing to see very positive earnings surprises," said Earnings Scout 's Nick Raich.

Surprises and raised earnings

Stocks are expensive. The S&P 500 is trading at a historically high 22 times 2021 earnings. For stocks to keep advancing, two things had to happen: very large earnings beats for the fourth quarter and sufficiently clear corporate guidance that earnings estimates for Q1, 2, and 3 would keep rising. 

Both of these conditions have been met. First, earnings are beating estimates by more than 17%, about five times the normal average and on a par with the third quarter. The reason: Analysts have underestimated the strength of the economic recovery.

Q4 earnings: halfway point (53% reporting)

  • Beating: 83%
  • Percentage above estimates: 17.3%
  • EPS growth: up 1.6%

Second, earnings surprises are now translating into higher estimates for the first and second quarters.

S&P 500: Q1 2020 earnings estimates

  • Jan. 1: up 16%
  • Today: up 20.5% 

S&P 500: Q2 2020 earnings estimates

  • Jan. 1: up 45.7%
  • Today: up 49.9%

Source: Refinitiv

Analysts typically are overly optimistic and start cutting estimates as the quarter wears on, but in the second quarter the opposite has happened.

"That's an unusual occurrence; the Street is usually cutting numbers by this point in the current quarter," DataTrek's Nicholas Colas said in a recent note.

Technology, materials and real estate earnings have been particularly strong.

Sell the news?

With stocks this high, it's little wonder that even strong earnings reports don't move individual stocks much. Christopher Harvey, head of equity strategy at Wells Fargo, has noted that in the 24-hour period companies reported positive earnings beats, the average stock traded down 0.8%.

Ann Larson, senior analyst at Bernstein, noted that the S&P 500 had run up about 18% in the previous 2½ months, "perhaps discounting much of the good earnings results in advance."

Low rates + strong earnings = stocks at new highs

Another factor pushing stocks to new highs is low interest rates.

"The U.S. has never begun an expansion with yields as low as today," chief investment strategist Jim Paulsen of The Leuthold Group said in a recent note. "A combination of extremely low yields and strong EPS gains has historically proved to be a uniquely positive opportunity for stock investors."

What could derail the earnings lollapalooza? Barring another out-of-left-field event like GameStop, it's still all about the stimulus (go big is going to succeed, it appears) and the vaccine: "Covid is still a huge X-factor," Raich said. "Will there be mutations and will the vaccines still be as effective as advertised?  Barring that, stocks should continue to climb higher."

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