Record surprises… again!

What you need to know

• The first-quarter earnings season has been much better than expectations, with almost all regions and sectors beating consensus earnings and sales forecasts.
• Markets have reacted positively to strong beats in more cyclical sectors – especially financials – but strong beats in technology have not been rewarded. This is a sign that the market remains in rotation mode for now as it shifts from rerating covid winners to recovering covid losers.
• Our view remains that after an initial rerating of covid losers, the market will likely once again become more selective, favouring companies in industries with attractive competitive dynamics, innovative business models, and with solid cyclical or structural growth prospects.

Record beats
With 87% of companies in the US, 70% in Europe and 62% in emerging markets (EMs) having reported results (as of 6 May 2021), first-quarter growth figures are coming in far stronger than expected (figure 1). Although we’re reviewing quarterly figures, it’s important to remain focused as always on medium- to longer-term trends rather than assessing companies on short-term performance.

The percentage of companies beating expectations is the highest on record both in the US and in Europe. For instance, Europe’s 70% beat ratio compares to an average of 55% since 2009. The aggregate earnings growth rate surprises of around 25% are on a par with the last record highs seen in 2010 post the Global Financial Crisis, which shows the extraordinary nature of the shock companies endured at the start of 2020. Notably, the year-on-year comparisons for this quarter and the coming ones will likely be distorted by the (low) starting points of 2020. Europe aggregate earnings remain over 40% below end-2019 levels, while US levels are only around 10% lower.


Past performance is not a reliable indicator of future returns.

US beats across all sectors but Europe shows notable improvement
Almost all sectors have surprised versus expectations, both in Europe and in the US. It is interesting to observe in the short term that the market has reacted to strong beats differently depending on the sector. For instance, strong earnings from banks have been rewarded recently, while strong earnings from tech/internet companies have not.

Our view is that much of the current growth success from tech/internet companies was already embedded in share prices and renewed strength will likely require further long-term profits growth. Meanwhile, the market continues to reward the more cyclical segments that suffered heavily from the pandemic. As a number of these businesses have recovered to pre-covid levels, further upside may require further improvement in their growth prospects.

The headline earnings from sectors are sometimes dominated by extreme results from a small number of companies within them. We explore key sector trends below:

Tech/internet services: Beats in the US were once again substantial in the tech and internet-related segments (figure 2), with index heavyweights reporting stellar profits, including Apple, Alphabet and Facebook. In Europe, Nokia and STMicro surprised positively the most.
Consumer discretionary: Notable strong performance from the likes of Amazon and Ford in the US, and in Europe autos companies (BMW and Continental) and consumer businesses (Electralux).
Financials: In the US, there have been notable surprises from banks (Goldman Sachs, Capital One and Wells Fargo) and non-bank financials (Amex). In Europe higher earnings have been rewarded with better short-term price performance (Lloyds Banking Group).
Healthcare: The sector is performing operationally as one should expect in a recovery. Europe has enjoyed solid beats across the board, with Fresenius SE a top contributor.
Utilities: Not many companies in Europe have reported and negative results are so far being impacted by Scatec (renewable energy) and Orsted.
Communications services: In Europe, only a few companies have reporting figures so far, namely Telia and Tele2, which are skewing the numbers somewhat.
Consumer staples: Whilst past performance is not a reliable indicator of future returns, year-over-year EPS growth figures in Europe look very high (figure 3), largely because of the substantial increase in profits by Anhauser-Bush Inbev, which missed expectations in Q1.

Looking ahead
Over a multi-year horizon, we maintain our positive view on companies and sectors that we believe to be on the right side of structural change, such as technology and healthcare. Both sectors have reported solid results and we believe they potentially remain well-placed to continue to benefit from their respective structural growth drivers, even though they might fall out of fashion with investors in the short term. As legendary investor Benjamin Graham noted: “In the short run, the market is a voting machine but in the long run, it is a weighing machine.”

In assessing our sector views, we remain mindful of ESG challenges for certain sectors, which may  lead us to forego short-term upside as we stick to the principles of our sustainable investment approach.
Elsewhere, with our macro view remaining constructive, we continue to see good support for smaller businesses and maintain our tactical overweight to UK smaller companies.