Stock market skeptics, who fear that the race for all-time highs to close tumultuous 2020 will be fueled by an unwarranted round of investor euphoria, may be ignoring an important wind in favor, according to analysts at Jefferies .
Skepticism is understandable, they acknowledged, in a note on Saturday, noting that market performance at the end of 2020 is “almost the opposite” of the double-digit declines seen in the fourth quarter of 2018, despite the flow of comments and news carrying a “similarly severe tone.”
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The S&P 500 SPX,
fell 14% in the last quarter of 2018, a wave of sales sparked by fears that the Federal Reserve’s overly tight monetary policy would suffocate the economy. The benchmark index has risen more than 10% so far in the last quarter of 2020, despite the increase in cases of coronaviruses that threaten to hamper the economic recovery, even with vaccines being launched in the United States and in much of the world.
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In their most fundamental aspect, stocks refer to 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 in the quarter, analysts wrote.
“We would say that this is one of the most important favorable winds for stocks, as earnings reviews are rarely positive,” they said.
Profit reviews 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 revised downward over a quarter, effectively lowering the bar when the ongoing earnings season comes.
As the chart below shows, upward revisions have become a rare event. But history shows that stocks tend to go up when they do, analysts noted.
Jefferies
How much tail wind? Analysts said the S&P 500’s average three-month top performance in the wake of positive reviews is almost 450 basis points, or 4.5 percentage points, “which bodes well” for the S&P 500 in the first quarter of 2021 (see table below).
Jefferies
And, since vaccine deployments have just begun, the potential remains for further positive reviews in the first half of next year, they said.
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As the table above shows, even lower than average negative revisions tend to lead to solid performance by the S&P 500. In fact, it is only when revisions start to drop significantly that performance tends to slow down, analysts found.
So, in full swing for 2021? Not so fast.
Analysts said the reach of strong market gains in December, which saw the S&P 500 rise more than 3% in the month so far, while the Dow Jones Industrial Average DJIA,
advanced by 2.8% and the Nasdaq Composite COMP,
gained more than 5.5% and could pave the way for a brief retraction in January.
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“The current performance of December is about 50 basis points above the average since 1990 and, when that happens, the performance of January is positive only half the time,” they noted. However, in these cases, the first quarter’s performance was stronger than usual, with the S&P 500 rising more than 80% of the time.
“For a while [near-term] the returns can be bad, but it can also be a good time to increase exposure, ”they said.