U.S. equity markets rallied higher last week as investors were encouraged by the initial reports from the fourth quarter corporate earnings season, which has gotten off to a strong start. For the week, the tech-heavy Nasdaq Composite surged 4.2%, while the S&P 500 and Dow Jones gained 2.0% and 0.6%, respectively. Small cap stocks have continued their outperformance from late last year with the Russell 2000 index up almost 10% this year as of Friday’s close compared to 2.4% for the S&P 500. Small cap company earnings are generally more economically sensitive, so growing traction for the economic recovery, additional stimulus, and the vaccine rollout has boosted their relative performance versus larger peers.
The first round of corporate earnings announcements for the fourth quarter of 2020 was positively received, beating expectations by a wide margin. According to FactSet, of the 67 companies from the S&P 500 that have reported, 86% have surpassed consensus earnings forecasts, and reported earnings have exceeded forecasts by almost 22% in aggregate. The earnings upside reinforces positive traction in the economic recovery, but market participants are also keying in on forward looking guidance from management teams to see how well growth will be sustained in the coming year.
Although an improving economic and corporate earnings outlook have been supportive of rising equity markets, there has been increasing scrutiny on certain pockets of financial markets where valuations are looking extended and where speculative trading activity, including surging call option purchases, has ramped up considerably in recent months. The surge in companies going public through IPOs and through mergers with Special Purpose Acquisition Companies (SPACs) has punctuated the rise in market risk appetite. A SPAC is a publicly traded shell company whose single purpose is to merge with another company, taking them public in the process. So far in 2021, there have been an average of 5 new SPACs created each market day and there are now nearly 300 SPACs armed with around $90 billion that are seeking private companies to merge with and bring public.
Meanwhile, progress on another round of stimulus is also garnering a lot of attention as a bipartisan group of Senators is pushing back against the $1.9 trillion proposed package announced by the Biden administration in favor of a smaller bill with more targeted stimulus payments. Cyclical stocks like financials and materials have lagged the market in response to the uncertainty, as a reduced stimulus package could dampen expectations for economic growth and inflation.
A significant round of corporate earnings announcements is on tap in the week ahead including large U.S. technology companies like Facebook, Microsoft, and Apple. As of yearend, the top five names of the S&P 500 (Alphabet, Amazon, Apple, Facebook, and Microsoft) accounted for almost 22% of the market cap weighted index, so their performance and outlook carries a lot of influence in setting the tone for the broader market. In addition to earnings results, there are several notable economic announcements on the docket in the week ahead including the first preliminary look at U.S. fourth quarter GDP growth. The consensus forecast is for economic growth of 4.2% over the third quarter, which would be down about -2.5% compared to the fourth quarter of 2019.
