Earnings in Q2 likely contracted by a whopping -45%—the worst since 2008. What does that mean for markets?

Our Top Market Takeaways for July 10, 2020.

Winners keep winning


The head scratching is back: Why, even in the face of seven new records in U.S. daily new infections this past month, has the stock market remained relatively undaunted? Sure, it’s been a bumpy ride (the average magnitude of the index’s daily moves over the last month has been 1.2%, versus 2019’s 0.56% average), but heading into Friday, the S&P 500 is only down -1.7% over the same period.

Looking beyond the headline index reveals a familiar trend: Investors are again flocking to virus-resilient segments of the market and leaving May’s pro-cyclical, “back-to-normal-life” trades behind. Just since the start of July, the combined market caps of the S&P 500’s five biggest companies (Facebook, Apple, Amazon, Alphabet and Microsoft) have grown by more than the actual market cap of any other company in the index. Those five companies, along with other digital sphere leaders, are still seeing their stock prices climb higher while the pandemic’s hardest hit sectors (e.g., banks) are back in a slump. 

The chart displays the price index of the S&P 500, FANG+ (Tesla, Amazon, Netflix, Alibaba, Baidu, Apple, Nvidia, Google, Facebook and Twitter) and U.S. Banks from December 2019 through June 2020. It indicates that during this time period, FANG+ has grown more in comparison to the S&P 500 and U.S. Banks.

We expect the market to continue reflecting the risks COVID-19 poses for economies’ ability to remain open. Companies able to operate in the digital sphere are likely to outperform those reliant on physical spaces and mobility, at least until curves flatten again. It’s still our view that April–June likely captured the worst of the pandemic’s economic fallout, so the Q2 earnings season (which kicks off next week in the United States) will give us a real baseline against which we can measure companies’ resilience under the most dire economic conditions of this unique time.   

5 things to know this earnings season


Earnings season always creates a lot of chatter, but this one is worthy of all the buzz. The Q2 reporting season will mark the first quarter that shows the full brunt of lockdowns that shuttered activity. Here are five things to know heading into this earnings season.

1. It’s tough to be disappointed when your expectations were already low.

Investors are bracing for the worst earnings season since 2008…and it just so happens to follow the best quarter for S&P 500 returns in 20 years. Analysts have cut profit estimates at the fastest pace on record, and consensus is calling for S&P 500 Q2 earnings to contract an eye-popping -45% versus the year prior (last quarter, EPS dropped by -15% over the prior year, but six of 11 sectors still eked out positive growth). For Europe, the outlook is even bleaker—analysts are calling for a -61% decline in earnings year-over-year.

But with such dismal earnings, are we bracing for a fall in stock prices? We don’t think so. Markets are anticipation machines, and it’s unlikely earnings will come in worse than what’s already expected. Rather, it’s more likely that profitability will beat dire estimates and put wind in the sails of the rally.


2. Expect a big divergence between sectors.

All 11 S&P 500 sectors are expected to post negative year-over-year earnings per share growth—an all-too-familiar reminder that no one has been really immune to the global shutdown.

The hardest hit sector looks to be energy (plagued by a shutdown in demand, and in the case of oil, a glut of supply), joined by consumer discretionary (think: leisure, apparel and restaurants), industrials (remember airlines?), and financials (which were the biggest disappointment in Q1). Each of these sectors is expected to see earnings contract this quarter by -50% or more!

Meanwhile, tech companies (which, by the way, represent 30% of the S&P by both market cap and by aggregate earnings per share) look set to continue their triumphant stride—analysts are expecting earnings to contract by only -9% versus the prior year. The utilities sector also looks likely to come out relatively unscathed—earnings are expected to contract by only -3% this quarter.

All in all, earnings season looks to set to confirm what the stock market has been telling us: There are winners and losers in this crisis.

The chart shows the Q2 2020 earnings per share (EPS) versus the prior year as a percent change across sectors. It indicates that all 11 S&P 500 sectors are expected to post negative year-over-year earnings per share growth.

3. Uncertainty abounds.

Most CEOs have abandoned forecasts for Q2 results. Heading into this season, there have been only 49 preannouncements for S&P 500 companies—a far cry from the five-year average of 106. Those preannouncements are also pretty mixed: 27 companies have seen negative revisions, while 22 have seen positive revisions. Albeit the small sample size, that positive/negative balance represents a 55% miss rate, which is actually better than the 70% average. We’ll take all the bright spots we can get.


4. Investors care most about turning the page.

Similar to the “pass”’ that markets gave the abysmal economic data of March/April, investors are calling this earnings season (and all of 2020’s) a wash. Instead, 2021 earnings expectations are in focus—which, by the way, are roughly in line with where earnings were in 2019. 

The chart shows 2020 EPS expectations and 2021 EPS expectations from June 2019 through June 2020 compared to the 2019 EPS. It indicates that markets are pricing in earnings weakness through 2020, while 2021 expectations are in line with 2019 EPS.

As the results roll in, investors will be particularly focused on what forward guidance companies might provide for the quarters ahead; 183 S&P 500 companies have already withdrawn guidance, and it’s likely this trend will continue into Q3. Nonetheless, we’re keen for whatever information we can get—in particular, what margins might look like, the process of reopening and key changes in operations, and the future of dividend payments.


5. The earnings recovery will likely follow the economic and market rebound…eventually.

Over the last two months, economic data has continued to inflect higher, following the lead of markets. So will earnings follow too? We think so, but it may take some time. Earnings lag, and with the path of the virus still uncertain and rollbacks of reopening occurring in some areas of the country, it’s likely corporate profitability will hit further bumps in the road. Q3 earnings will likely fare much better than Q2, but we think the real rebound in earnings will come in 2021.

“Please scream inside your heart”


PSA for any rollercoaster buffs out there: A number of Japanese amusement parks are open again, but please contain your thrill…literally. In addition to urging visitors to wear masks, park officials are also asking them to refrain from screaming on rides, given health officials’ warnings that such reactions can project potentially virus-laden droplets. Catch a video of two park executives showing how it’s done. Their advice: “Please scream inside your heart.”

People wearing protective masks enjoy the Blue Fire roller coaster at Europa-Park, Germany's largest theme park, in Rust, on May 29, 2020 during the reopening day after several weeks of lockdown measures taken to curb the spread of the COVID-19 pandemic, caused by the novel coronavirus. (Photo by PATRICK HERTZOG / AFP)

All market and economic data as of July 2020 and sourced from Bloomberg and FactSet unless otherwise stated.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.


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