Wall St Week Ahead: As political risk fades, earnings may start to matter again

With uncertainties regarding US elections fading, some investors expect company earnings and economic data to play a greater role in moving stock prices this year.

For months, earnings and economic data have largely taken a backseat as investors grappled with two overarching uncertainties and their ultimate impact on financial markets: the changing political landscape in Washington and the coronavirus pandemic sweeping the globe.

Options data showed that bets on large earnings-related stock moves were profitable only 24% of the time in the last earnings season, compared with a historical win rate of about 40%, according to options analytics firm ORATS.

Stocks have surged to record highs even as Citigroup's US Economic Surprise Index, which tracks economic data relative to expectations, has slipped to its lowest level in six months.

"In 2020, the fundamentals kind of went out the window," said Matt Amberson, principal at ORATS.

Graphic: No surprise

Some investors believe that is about to change. The resolution of the Georgia Senate runoffs tipped control of the chamber to Democrats earlier this week. That gave investors more clarity on fiscal policies that will have a greater chance of being advanced in 2021, namely, President-elect Joe Biden's proposals for increased fiscal spending and higher taxes.

Congress certified Biden's election victory early on Thursday, hours after hundreds of President Donald Trump's supporters stormed the US Capitol in a shocking display that weighed only briefly on markets.

"With less focus on politics, there is greater bandwidth for focusing on other issues such as Covid and economic fundamentals," said James Knightley, chief international economist at ING in New York.

Stocks overcame early weakness to close at a record high on Friday despite data showing the US economy shed jobs for the first time in eight months amid a resurgence of Covid-19 infections.

Investors will get a snapshot of how the economy is performing next week with the release of data on inflation, retail sales and consumer sentiment.

JP Morgan, Citigroup and Wells Fargo are set to release fourth-quarter results on Jan. 15, among the first S&P 500 companies to post their results for the last period of coronavirus-stricken 2020.

Overall, S&P 500 company earnings are forecast to increase about 23% in 2021 compared with pandemic-hit 2020, leaving investors with the task of figuring out how much of that is sustainable.

Many are likely to be more discerning than they were last year, said Mohannad Aama, managing director at Beam Capital Management.

Investors may be in for a certain degree of rotation, with companies whose businesses were battered by the pandemic in 2020 expected to show strong rebounds this year, analysts said.

The worst-performing sector in 2020, energy, is Aama's top pick for 2021. The sector is expected to post earnings growth of 668% in 2021, according to I/B/E/S data from Refinitiv.

Earnings growth for industrials, consumer discretionary and materials is expected to far outpace the earnings growth for the technology sector, data showed.

To be sure, expectations of fiscal stimulus and ultra low interest rates for the long term fueled "everything rallies" that have buoyed assets from big technology stocks to small caps, convincing some investors that betting on broader gains may be preferable than trying to be too selective. So far, that phenomenon has persisted into 2021, with the S&P 500 and tech-heavy Nasdaq both hitting new highs.

At the same time, investors may return to the "stay at home" trade that benefited big technology stocks if the coronavirus resurgence grows or the vaccine rollout goes awry.

Still, some investors believe a more refined approach may be key to stock selection in 2021.

For most of 2020, "you had a market that really didn't care if a company missed earnings or met earnings. All it cared about was stimulus and vaccines," said Robert Almeida, portfolio manager and global investment strategist at MFS Investment Management.

Now, "the market will be forced to reorient its attention on micro versus macro," he said.