This stage of the recovery is when equities do tend to be most expensive: Deutsche Bank’s Binky Chadha

Deutsche Bank’s chief global strategist Binky Chadha breaks down his analysis of the current state of markets and the economy.

Video transcript

JULIE HYMAN: As we've been discussing, it is another busy day for earnings. We ran through some of the numbers at the top of the show. But also, it's good to take a step back and look at the overall earnings season, what the expectations are, how companies will actually do, and what that is going to mean for stocks.

For all that discussion, we bring in Binky Chadha now. He's Chief US Equity and Global Strategist at Deutsche Bank Securities. Binky, it's great to see you. So as you look at some of the early numbers that we've gotten thus far and compare it with expectations, you know, typically companies beat, right, on an individual basis. How is the margin by which they are beating? And do you think that-- that maybe some analysts are still too pessimistic about what we might get this earnings season?

BINKY CHADHA: Yeah, hi, Julie. You know, the point that I would make is you've got to put this earnings season in the context of the last three, where we got, basically, off-the-charts record beats. And so coming into this earnings season what we saw is the biggest upgrade that we've ever seen. So the bar was raised.

And you know, the question is, is it high enough? I think the results that we've seen so far suggest, as we thought, that, yes, the bar has been raised, but not enough. We are still expecting a pretty big beat. I would say for the S&P 500, 7% to 8%.

The numbers that we're getting right now are dominated, basically, by the financials. And that's really a question about the loan loss provisioning. What we are seeing basically is releases as opposed to what the consensus had which is a build up. I think if you X out the loan loss provisioning, we are still talking about 7% to 8% beats, which is kind of what we expected.

And I think, you know, the important takeaway is that after 3/4 of big beats, after big raise coming into earnings season, you know, if earnings do beat basically by 7% to 8% and the bottom-up consensus upgrades the forward quarters in line with that, I would say that-- that would put us sort of at, you know, one year of basically peak upgrades in this quarter. And so I think this eight-- pattern of 8%, 10%, 15%, and 20% beats, you know, is sort of peaking.

MYLES UDLAND: And you know, Binky, in the context of things that might also be peaking, you guys have written recently about macro growth, which we get a little bit more of a real time feel for than past-looking quarterly earnings data. How are you thinking about the next round of PMIs, I guess we're a couple weeks out from getting that April data, and how that's impacting your outlook today?

BINKY CHADHA: Sure. I mean, I think, you know, when one thinks about the economic outlook, the first thing one does, of course, is listen to our and the Street's economists. And you know, the consensus or house view is very much basically for a peak in growth in the second quarter. You know, the economists have the luxury of basically operating on a quarterly frequency.

A quarter is a very long time in equity markets. And so, you know, I think the focus should really be on, you know, what the equity market has historically focused on, which is sort of monthly and higher-frequency indicators. And I would say the ISMs are key here. We have a peak, as I said, in quarterly GDP growth in the second quarter. And that suggests, of course, that the ISMs peak in this quarter. I would say, you know, there's a number of sort of factors that suggest that the peak could be sort of very sharp, basically, in this quarter.

Keep in mind that the ISM-- you know, the ISM manufacturing is already at a 37, 38-year high at 64 and 1/2. And so that just increases, basically, the likelihood that we get, you know, the typical sort of historical pattern which, you know, has sort of been an inverted V sort of about a year into the recovery, which is kind of exactly where, you know, I would put us in the recovery. And I think the important thing to note is that basically the ISM's peak, you know, about a year after the recovery begins, and then that's generally been associated with, you know, pretty notable, significant consolidation, basically, in the equity markets. And we would put that at about 6% to 10% this time around.

BRIAN SOZZI: There we had the opening bell on Wall Street, stocks opening in the red today. The S&P 500, Dow, NASDAQ, and the Russell 2000 all in the red, lots of earnings to start digesting. Binky, do you think there's-- there's too much exuberance in markets right now?

BINKY CHADHA: I think that, you know, the equity rally, I mean, if you think about, you know, since the March bottom and you think about it relative to the drivers, I would say, you know, it's a little bit on the exuberant side. But I would say that the rally has been-- you know, is not difficult to explain in terms of, basically, the traditional drivers. After all, you know, we did have growth also bottom, basically, back in April of last year. Growth has been coming in, you know, very strong if you look at any indicator of macro data surprises, we'd say, you know, nine months of positive surprises.

We just spoke about earnings. We've had, basically, this is going to be the fourth quarter of big, big beats. So we've had, basically, macro growth accelerating, earnings getting upgraded. That's generally, basically, very supportive environment for equities. And if you think about, you know, in terms of valuation, we have an estimate for this year's earnings of $202. The bottom-up consensus has continued, basically, to get upgraded, but it's still at about $185 or so.

And so it's still got some, you know, further room for upgrades. We think most of that gap is basically closed with first quarter earnings results. And so some of these drivers are basically, you know, diminishing. The traditional metric for thinking about whether, you know, stocks are overexuberant is valuation. I would argue valuation has an impact, basically, slowly.

And you know, if you look at the S&P 500, you know, relative to our earnings estimates, we are south of 20. It is at this stage of the recovery when, you know, equities do tend to be the most expensive as the market sort of prices in the recovery. And so I would argue, you know, yes, there's exuberance, but it's been pretty easy to explain in terms of, you know, what has always mattered. I mean, I think there are some differences this time around.

And last but not least, what I would say is, you know, if you look at our earnings numbers, whatever you think the multiple was on December 31 of last year, you know, if you're talking about 45% growth in earnings, I mean, there's a lot of room, basically, for valuation to come down as long as markets don't go up by 45%. And we certainly don't expect that. And even, you know, 15% or 20% will imply, basically, a 20%, you know, correction in valuation. And you know, if we were to judge how expensive stocks are today at the market level, we would be talking about 15%, 20%, 25%, depending on the estimate you use.

So I think that a soft landing on the valuation front is not only very possible, it's very likely. I mean, I think other catalysts for a pullback are going to be as, if not more, important. As we just spoke about, you know, a peak in growth typically occurs, you know, pretty soon after a recession. That's generally associated with a sell-off. But I would think about that as really a pullback, and the market will come back afterwards.

JULIE HYMAN: We talk to a lot of bulls on the show, but nobody who has suggested a 45% gain from here. But yeah, so what you're talking about sounds more reasonable. Binky Chadha, always good to get some time with you. Really appreciate it this morning. Chief US Equity Global-- Equity and Global Strategist-- excuse me-- at Deutsche Bank Securities.