Stock market skeptics, fearing that the flight to record highs to hedge a tumultuous 2020 will be fueled by an unwarranted round of investor euphoria, could overlook a significant tailwind, according to Jefferies analysts.
Skepticism is understandable, they acknowledged in a Saturday note, noting that market performance heading towards the end of 2020 is “ almost the opposite ” of the double-digit declines in the fourth quarter of 2018, despite comments and news with a “ similar ” stiff tone. “
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The S&P 500 SPX,
fell 14% in the last quarter of 2018, a sell-off prompted by fears that too tight monetary policy from the Federal Reserve would stifle the economy. The benchmark index is up more than 10% so far in the last quarter of 2020, despite rising coronavirus cases threatening to derail an economic recovery, even as vaccines are rolled out in the US and much of the world.
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In their most fundamental way, stocks are about future earnings. And the “notable difference” in the last three months of 2020 is that earnings revisions for the period were positive almost every week of the quarter, the analysts wrote.
“We would argue that this is one of the major windfalls for equities as earnings revisions are rarely positive,” they said.
Earnings revisions refer to changes in analysts’ estimates for corporate earnings in a quarter – in this case for the companies that make up the S&P 500. Typically, expectations are adjusted lower over the course of a quarter, effectively lowering the bar when the earnings season is on the way.
As the chart below shows, upward revisions have become a rare occurrence. But history shows that stocks tend to grow upward when they occur, the analysts noted.
Jefferies
How much tailwind? The analysts said the average quarterly S&P 500 outperformance after positive revisions is nearly 450 basis points, or 4.5 percentage points, “boding well” for the S&P 500 in the first quarter of 2021 (see table below).
Jefferies
And since vaccine implementation has just begun, the potential for additional positive revisions remains in the first half of next year, they said.
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As the table above shows, even negative revisions smaller than average lead to solid performance from the S&P 500. In fact, performance does not slow down until revisions start to roll significantly, the analysts said.
So full steam ahead for 2021? Not so fast.
The analysts said the magnitude of the strong December gains in the marketplace, which drove the S&P 500 up more than 3% in the month so far, while the Dow Jones Industrial Average DJIA,
is up about 2.8% and the Nasdaq Composite COMP,
gains more than 5.5% could set the stage for a brief downturn in January.
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“Current December performance is about 50 basis points above the average since ’90, and when that happens, January performance is only positive about half the time,” they noted. In those cases, however, performance was stronger than normal in the first quarter, with the S&P 500 rising more than 80% of the time.
So while [near-term] returns may be moderate, but it could also be a good time to increase exposure, ”they said.