Weekly Stock Market And Economy Recap: S&P 500 EPS Up, FOMC, And Adobe Shines

S&P 500 earnings update

The Federal Open Market Committee (FOMC) released its statement and economic projections last week. There was no change for interest rates or its bond buying program ($80 billion treasuries, $40 billion mortgage backed securities per month). This was no surprise.

The big change came in the Fed’s economic projections for the economy, inflation, and the future path of interest rates. The Fed increased its projections for 2021 real GDP from 6.5% to 7.0%, and they also increased their inflation projections by a pretty wide margin. In March, the Fed’s core inflation projections were 2.2%, they now see core inflation at 3.0% this year.

As for the path of the Federal Funds rate (short term interest rate benchmark), in March, 4 of the 18 voting committee members forecasted an increase in rates for 2022, and 7 of 18 members forecasted an increase in rates for 2023. This means the majority of voting members saw no rate increases throughout 2023, which is why the median Federal Funds rate projection was 0.1% through 2023 in March.

Now 7 of 18 voting members see a rate increase in 2022, and 13 of 18 see a rate increase in 2023. Which means the majority of voting members now see rate increases by 2023. The median Federal funds rate projection is now 0.6% for 2023. This means not one, but two rate increases by 2023 is now the consensus.

Regular readers know I’ve been calling “BS” on the notion that the Fed would be able to keep rates at 0% for another 2+ years. We are seeing this play out right now. The market will need to adjust its expectations. More on this in the summary.

The Conference Board’s Leading Economic Index (LEI) increased to 114.5 in May, another record high. It was a gain of +1.3% for the month, as April was revised lower (from 113.3 to 113) and March was revised higher (from 111.5 to 111.6).

“After another large improvement in May, the U.S. LEI now stands above its previous peak reached in January 2020 (112.0), suggesting that strong economic growth will continue in the near term.

"Strengths among the leading indicators were widespread, with initial claims for unemployment insurance making the largest positive contribution to the index; housing permits made this month’s only negative contribution.

"The Conference Board now forecasts real GDP growth in Q2 could reach 9 percent (annualized), with year-over-year economic growth reaching 6.6 percent for 2021.”

The year over year growth rate in the LEI continues make all time highs, currently at +14.7%.

h2 Notable earnings/h2

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Quarterly revenues came in at $3.8 billion (driven by subscription and product sales), about 3% above street expectations and a growth rate of 23% over last year. The company guided for $3.88 billion in sales next quarter (orange bar), a 20% growth rate. Adobe has grown quarterly sales +20% in 21 of the last 25 quarters.

Gross margins improved to 88%, operating margins improved to 37% (operating income grew 43%), profit margins came in at 29%.

Net income is also moving in the right direction, as TTM profits now total $6.68 billion.

It’s not everyday that you see a company growing sales 20%+ consistently, with 87% gross margins and 38% profit margins.

And because the company is performing so well, the stock price trades at a premium. The stock broke out to another all time high after earnings, closing +2.6% higher on a day when just about everything else closed lower. I’ve owned the stock for years with no intentions to sell.

Adobe, Nvidia (NASDAQ:NVDA), Crowdstrike Holdings (NASDAQ:CRWD), Fortinet (NASDAQ:FTNT), Veeva Systems (NYSE:VEEV), ServiceNow (NYSE:NOW), Shopify (NYSE:SHOP), and Salesforce (NYSE:CRM) remain some of my favorite non FAANG tech stocks.

I would add to positions in all of them, whenever we get the next market correction.

h2 Chart of the week/h2

2021 EPS growth for the US is around +36% and rising. This is a global phenomenon, as most of the developed world is seeing record earnings growth. As of now, the UK is looking at close to 60% EPS growth this year.

Part of this has to do with US earnings growth declines in 2020 (-14%) not being as severe as the rest of the world. This economic recovery is widespread, which is good for the US too with its many multi-national companies.

Another reason to have some exposure to international stocks, even though the S&P 500 has outperformed for a long time.

h2 Summary/h2

The earnings and economic data this past week continued to confirm the expansion was intact. But that all took a back seat to the pivotal shift in the Fed’s stance on future monetary policy.

Last year I began saying that inflation was the biggest near term concern. And I seriously doubted the Fed could ever stick to its pledge of keeping rates at 0% throughout 2023. We are seeing that play out in real time now.

Frankly, I can’t believe Fed members are saying they were “surprised” by the inflation surge. The writing was on the wall awhile ago. Barring any unforeseen shocks to the system, I expect a winding down of the bond buying program by the start of 2022 (it will probably be announced in September), and to begin raising rates by the end of 2022.

But lets put this in context. The reason why the Fed is beginning to change course is because the economy is doing well. I could make the case that we don’t need crisis level monetary stimulus right now, never mind 2 year from now. This transition should be cheered, not feared.

Will this be a catalyst for a correction is anyone’s guess. I think the market may be worried the Fed is falling behind the curve. I won’t lie, this is a possibility but it’s too soon to tell. Let’s see what the CPI does in the next few months now that the easy year over year comparisons are over. A correction down to the vicinity of the 50 week moving average would be perfectly normal and healthy. Get your shopping list ready, just in case.

h2 This week/h2

We have 7 companies reporting earnings. I’ll be paying attention to Fed Ex (NYSE:FDX) and Nike (NYSE:NKE) on Thursday. For economic data we have new home sales on Wednesday, the 3rd and final look at Q1 GDP on Thursday (which will include updated corporate profits), Core PCE inflation and personal income on Friday.

/h2

Written By: Michael Gouvalaris