US stocks are facing a perfect alignment of conditions that will help monstrous earnings growth translate into sizable share gains, according to a Wall Street chief strategist
- Expectations for strong profit growth amid low yields in 2021 should send stocks soaring, said James Paulsen, the chief investment strategist for The Leuthold Group.
- Historically, periods with yields in their lowest tripartite allow for strong earnings to drive the biggest market gains.
- With economic reopening around the corner, stocks are poised to soar amid extremely low yields and healthy earnings growth, Paulsen said.
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Investors are paying more attention to earnings at just the right time, says James Paulsen, chief investment strategist at The Leuthold Group.
The market can finally see a light at the end of the tunnel. Vaccine distribution, the likelihood of more stimulus, and pent-up consumer demand all stand to supercharge economic growth through 2021. A return to pre-pandemic economic health will push investors' focus back to fundamentals, Paulsen said, adding the market's backdrop paves the way for strong returns.
The US has never started an economic growth cycle with lower yields than those seen today, and low yields have historically fueled hugely positive earnings rallies, according to the strategist.
In years when yields sit in their lowest tripartite like they do today, healthy earnings-per-share data prompt equally robust market gains. Conversely, stocks perform far worse when earnings are weakest in low-yield environments, according to Paulsen's analysis.
The dynamic shifts when yields sit higher. When Treasury yields stand in their middle tripartite, there's little difference in how earnings affect returns. Weak quarterly figures end up driving slightly stronger market returns, Paulsen said.
The lowest-tripartite trend flips when yields sit at relative highs. The strongest market gains historically came after weak earnings reads, while stocks performed far worse when earnings-per-share gained the most.
A handful of factors could explain the behavior, according to Paulsen. Low yields could exacerbate the appeal of strong earnings, as Treasurys make for less attractive alternative investments. Periods of high yields are also typically fraught with fears of out-of-control inflation. In such environments, strong earnings growth could further stoke concerns of economic overheating, the strategist said.
In contrast, historically low yields are usually seen when economic growth is poor and investors are concerned about earnings contraction. In these cases, robust earnings-per-share reads defy such fears and prompt new market bullishness, Paulsen said.
"The amazing stock market recovery of 2020 may continue well in 2021" amid a combination of low yields and healthy earnings growth, he added.