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Traders work on the floor of the New York Stock Exchange, on July 19.

Richard Drew/The Associated Press

The stock market juggernaut appears unstoppable at first glance, but there’s a gnawing concern about continuous profit upgrades just as economists scramble to scale back growth forecasts.

Although the second quarter of 2021 likely marks the peak of the post-pandemic bounceback, corporate results still managed to wow the gallery. Annual U.S. earnings almost doubled over the 12 months and European aggregates topped 150 per cent, with equity analysts pushing their year-end forecasts up again in the slipstream.

According to Refinitiv data, full-year S&P 500 profit growth has been revised up almost 10 percentage points to 45.8 per cent since July and is almost double the rate forecast in January.

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What’s more, net earnings upgrades have continued to stay positive now for 12 months solid, with August’s revisions for the S&P500 and MSCI’s all-country stock index at the highest since May – and the second best in over a decade.

U.S., European and global stock benchmarks have all powered to new record highs. Wall St’s S&P500 index has now clocked gains of more than 20 per cent so far this year, the first time in 24 years it has recorded gains of that magnitude for the first eight months of a calendar year – and only the 6th time in the past 50 years.

And so despite narratives of speculative price bubbles, those gains appear to be driven by bottom-up fundamentals and a rosy view of the broadening recovery. So much so forward price/earnings valuations have either flatlined or actually fallen through the year.

Although still above long-term averages, 12-month forward PE ratios for the MSCI all-country index are about two points cheaper than the start of 2021 or a year ago. The equivalent for the S&P is also slightly lower than in January.

Dizzying sectoral, country or regional rotations aside, broad stock indices measured on that basis appear more comfortable than relentless price gains might suggest.

The big question is whether the forward earnings euphoria and continuous upgrades are justified.

Some have their doubts.

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“Either our models are underestimating the degree of operational leverage left in this cycle or analysts are getting carried away with the latest earnings season and haven’t yet adjusted for the GDP downgrades,” said Pictet Asset Management strategist Arun Sai.

Sai points to surveys showing global growth expectations falling “drastically” since mid-year, due to China’s slowdown and the spreading Delta variant of COVID-19, and he contrasts that with the rising earnings upgrades.

Over the past 18 months, global growth forecasts have tended to drag earnings views higher and their sharp divergence now is eye-catching.

QUELLE SURPRISE?

There’s little doubt the world economy has lost momentum and high-frequency data is now disappointing consensus forecasts worldwide for the first time in over a year.

Citi’s global economic surprise index is at its most negative since June 2020. And all of the U.S., China, euro zone and U.K. sub-indices are sub-zero as well.

Major investment firms have moved to slash U.S. 2021 GDP calls, citing a more rapid cooling of household consumption and supply bottlenecks hitting manufacturing. Worldwide, China’s pursuit of zero COVID amid new variants and regulatory crackdowns has questioned the speed of the recovery too.

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On Thursday, Morgan Stanley more than halved its third-quarter U.S. growth forecast to 2.9 per cent – putting its full year at 5.7 per cent and below the Federal Reserve’s forecast for 7 per cent. Last month, Goldman Sachs cut its Q3 GDP forecast to 5.5 per cent from 9.0 per cent.

JPMorgan’s global manufacturing survey index slumped 2.5 points last month and it said this was only consistent with a mere 2 per cent annualized rate of growth – far below the 6 per cent rate it had bargained for. “The loss of momentum in the global goods producing sector at mid-year intensified in August.”

Will company analysts and stock markets be forced to recalibrate?

Amundi chief investment officer Pascal Blanque said he remained neutral overall on equities and cited three “Ds” as cause for concern – the Delta variant, deceleration of economic growth and a divergence in monetary and fiscal policies.

“The 3Ds are building a fertile ground for a return of market volatility, acting as a trigger for a pause in the equity rally and for relative value,” he told clients.

Counter arguments abound of course.

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Many of the incoming GDP forecasts are focused on the third quarter alone and either see 2022 views unchanged or even lifted as supply problems are expected to dissipate eventually and COVID worries ebb further into next year. This may explain why 12-month forward earnings continue to move higher regardless.

Companies claim they are able to pass on input cost rises to consumers fairly easily. And many are still awash with cash after last year’s precautionary borrowing spree. So, even if the earnings view were tempered, increasing buybacks and dividend payouts may justify some further rise in aggregate valuations.

What’s more, if the world growth slowdown or Delta variant were to bite harder, it may well delay any tapering of monetary support from the Fed or other central banks and once again enhance valuations in long-duration stocks such as Big Tech.

Either way, this seemingly carefree bull market is causing more headaches than it seems.

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