The one certainty about the outlook for companies in a COVID-19 world is that second-quarter earnings will be very bad — the worst, in fact, in more than 10 years.
Although Wall Street is betting that earnings will start bouncing off the bottom in the third quarter, the beginning point for that bounce is unknown, and early indications suggest the rebound’s magnitude may not match investors’ hopes.
As usual ahead of earnings season, since the reports cover the three-month period that has already passed, what companies say about the current quarter or the full year is more important than the results they’re reporting. But this earnings season may be different, as uncertainty over the impact of the COVID-19 pandemic has led many companies to withdraw guidance, leaving analysts more blinkered than usual when setting estimates.
About a third of S&P 500 /zigman2/quotes/210599714/realtime SPX +1.95% component companies have pulled their financial guidance, and less than half the typical number of companies have so far provided quarterly updates ahead of earnings, according to Sebastian Leburn, senior portfolio manager at Boston Private. “There’s a deficit of information that needs to be filled at some point,” Leburn said in an interview with MarketWatch.
That puts the trajectory of the anticipated earnings bounce, which stock investors are banking on, on unsure footing.
“That’s why I think earnings will be very important, because they’ll provide a dose of reality,” Brad Cornell, professor emeritus of finance at UCLA, told MarketWatch. “They are going to tell us exactly whether a company is on a path that justifies this run-up.”
One aspect of the rally in stocks over the past few months is that it has been driven by a shrinking set of mega-capitalization companies expected to benefit in a post–COVID-19 world. All five of the most highly valued companies in the S&P 500 index — Apple Inc. /zigman2/quotes/202934861/composite AAPL +1.07% , Microsoft Corp. /zigman2/quotes/207732364/composite MSFT +2.15% , Amazon.com Inc. /zigman2/quotes/210331248/composite AMZN +0.77% , Google parent Alphabet Inc. /zigman2/quotes/202490156/composite GOOGL +3.10% /zigman2/quotes/202490156/composite GOOGL +3.10% and Facebook Inc. /zigman2/quotes/205064656/composite FB +2.58% — have rallied by a double-digit percentage in 2020 through Friday, while the S&P 500 has lost 1.4%.
‘That’s why I think earnings will be very important, because they’ll provide a dose of reality. They are going to tell us exactly whether a company is on a path that justifies this run-up.’
Brad Cornell, UCLA
Those five companies have a combined weighting of more than 20% in the index, according to data provided by FactSet. That increases the risk for the broader stock market, as it heightens the importance of the earnings performance of a smaller set of companies. Disappointing results from other companies viewed as post–COVID-19 winners could also sap the market’s strength.
It’s not just the results that matter; so will any financial guidance they can provide to help justify the stocks’ gains.
“It’s all about clarity and having some guidance,” said Boston Private’s Leburn. “Without that, you have nothing to work with.”
The bad news is the actual numbers
The second-quarter earnings reporting season for S&P 500 companies unofficially kicks off before Tuesday’s opening bell, when a number of banks reveal their results.
The aggregate blended year-over-year growth estimate for earnings per share, which includes some earnings already reported and the average analyst estimates of coming results, is negative 44.6% as of Monday morning, according to FactSet. That would be the biggest decline in earnings since the fourth quarter of 2008, when earnings fell 70% in the midst of the financial crisis. It would follow 1% earnings growth in the first quarter.
“Second-quarter earnings will likely be a ‘kitchen sink’ report from many companies,” said Marc Lichtenfeld, chief income strategist with the investment and business newsletter publisher the Oxford Club. “They can throw in all of their write-offs and other expenses and know they will likely be forgiven for an earnings miss due to the extenuating circumstances.”
The current estimate marks a sharp drop in expectations as the coronavirus pandemic took firmer hold: The estimate as of March 31 was for a decline of just 11.1%.
All 11 S&P 500 sectors are expected to suffer negative earnings growth, led by energy, where earnings are projected to have fallen 152.6%, and consumer discretionary, which includes Amazon, where a 118.0% decline is forecast. Financials, which kicks off earnings reporting season on Tuesday, are expected to see a 55.3% earnings drop.
Information technology, which includes Apple and Microsoft, is expected to show a 9.5% earnings decline, while communications services, which houses Alphabet and Facebook, is expected to fall 30.4%. The best performer is currently estimated to be the utilities sector, whose earnings are forecast to be down 1.8%.
The outlook for sales is much better, with analyst expectations pointing to an 11.0% decline overall, with health care and utilities are the two sectors projected to see year-over-year sales growth.
The outlook for the third quarter is also bleak, just not as bleak as the second quarter.
The blended earnings-per-share estimate is for a drop of 24.4%, which compares with expectations of a decline of just 1% as of March 31. That would mark a second straight quarter of negative earnings growth, which by definition would mark the kickoff of an earnings recession.
That implies a bounce that recovers less that half the earnings lost since the first quarter. In comparison, the S&P 500 has retraced about 82% through Friday, of the COVID-19 selloff from the Feb. 19 record-high close of 3,386.15 to the March 23 closing low of 2,237.40.
All 11 S&P 500 sectors are currently projected to suffer negative third-quarter earnings growth, led by energy at down 113.5% and industrials at down 59.9%. The best expected performer is utilities, at a 0.1%earnings decline.
Meanwhile, third-quarter sales are expected to decline at a 5.5% rate.
Winners and losers in a new world
Although the earnings outlook for the overall S&P 500 is uniformly negative, investors have made a clear distinction between companies expected to end up as winners in a post–COVID-19 world and those that will struggle.
Many believe the COVID crisis is creating a new world, while others believe the pandemic has just sped up the future.
“Historically speaking, crises have tended to accelerate macro trends already in place,” said Yancey Spruill, chief executive officer at DigitalOcean, a cloud infrastructure company. “The clear winners are enterprise technology companies whose infrastructure or software supports the shift to remote work environments and deliver services to customers in a low-friction manner through an internet-based interface.”