The first quarter earnings season had something for everyone. On a positive note, Corporate America delivered solid results outside of the COVID 19 pandemic, which included retailers, travel companies, and banks. At the same time, earnings estimates for 2020 have dropped and a return to “normal” income could be two years or more away.
LOW BAR proved difficult to erase
At the start of the corporate earnings reporting season in the first quarter, we realized that the profit threshold was probably not low enough given the sudden shutdowns in March. This has proven to be correct as the S&P 500 Index’s earnings fell 14% year over year compared to March 31 expectations for a decline of around 5%. The big difference was not particularly surprising after many companies withdrew their forecast in mid-March after the rapid and severe economic shock. The shortfall also occurred despite one of the broadest rounds of cutbacks ever observed when 93% of the change in estimates were cutbacks from late March to early April (source: Bespoke Investment Group).
Widening the gap between winners and losers
We also expected the results to drive an even bigger wedge between winners and losers. We can look at the sectors that led to earnings growth in the first quarter to identify the pandemic winners that contributed most to overall earnings growth in the last quarter [FIGURE 1].
- Healthcare benefits from COVID-19 testing and treatment and is a major beneficiary of the latest fiscal incentives – and more fiscal incentives could come in June. The sector has had relatively good earnings stability in a difficult economic environment in the past.
- Technology and communication services benefit from the work-from-home trend, be it by equipping home offices, enabling web conferences or entertainment with streaming services.
- Basic food for consumers Companies helped us store our shelves in March. Household products companies saw earnings growth of more than 13% year over year in the quarter, while earnings for beverage manufacturers within the index (including the adult variety) grew more than 6%.
On the other hand, virtually the entire decline in S&P 500 earnings in the last quarter came from two sectors: consumer discretionary and financials. Consumer discretion encompasses some of the hardest hit areas of the crisis, such as: B. Clothing, restaurants, retail, and travel and entertainment, including cruise ships, hotels, and casinos.
Financial data was preparing for a wave of loan defaults as banks dramatically increased loan loss provisions, which contributed to a 60% decline in bank profits for the quarter over the previous year. If we took these two sectors out, the quarterly result would be flat rather than down 14%. The industrial sector, which includes the competitive airlines, also weighed on the bottom line, but only by about half the discretion of consumers.
These results are generally consistent with our tactical sector recommendations, in which we rate communications services, healthcare and technology positively and negatively assess consumer discretion. Our views on the consumer staples, finance and industrial sectors are neutral.
ALL ABOUT GUIDE
Every quarter when we write about earnings, we say that forecasts are more important than the reported quarterly results. This statement was particularly true this season. Few companies issued guidelines in April or May that made sense given the uncertainty surrounding the reopening process. However, analysts have gathered enough information to reduce the 2020 estimates by about 20% in April and May (Source: FactSet). However, the greatest profit losses will most likely be in the current (second) quarter, when consensus profit estimates fell 30% in April alone.
A 20% reduction in annual earnings estimates corresponded to historically typical recessions. Given the severity of the (unofficial) recession that the US economy entered in March and the challenges facing many companies that involve social distancing, success could be greater this time. The counter-argument is that this recession may already be over as the United States is open for business – to varying degrees from state to state – and a vaccine could arrive later in the year. The 2008/09 recession lasted 18 months, but it could be over in six months.
2020 RESULTS FORECAST
At this time, we believe our guidance of $ 120 to $ 125 per share for the S&P 500’s earnings for 2020 is appropriate [FIGURE 2]. That’s about 25% less than in 2019 and slightly more than the average decline in previous recessions. Consensus estimates have dropped to around $ 128.50 per share (Source: FactSet). Although our headline is somewhat more pessimistic, we believe that the economic recovery in the United States is likely to remain stable by the end of the year and by 2021, supported by significant fiscal and monetary incentives and possible medical breakthroughs. We imagine a U-shaped or “Swoosh” recovery rather than a V-shaped one. A W-shaped recovery may be possible when a second wave of infection occurs. We now have more information than five weeks ago when we previewed the earnings season, but the risk that our earnings forecast is too optimistic is still high.
HARD MARKET ON VALUE
To value stocks based on their earnings, investors should look to 2021 and 2022 in view of their depression to expect a return to “normal”. Our S&P 500 fair value target range at the end of 2020 remains between 3,150 and 3,200, less than 7% compared to the market on May 22, which is at the lower end of the range. To get there, we use a value for money (PE) of around 19 and a normalized profit figure of $ 165. Such an annual rate of return may not be reached until late 2021 or early 2022, but with such low interest rates and a COVID-19 vaccine that is likely during that period, we can use a longer-term earnings target as a value stocks right now. Aggressive monetary policy incentives and low inflation can support higher PE multiples, even if these earnings are not achieved until 2022 or later.
In the short term, we still think stocks have come too far and too quickly, and a 10% decline would not surprise us. Historical patterns based on previous lows on the bear market support this view. For long-term investors, we continue to believe that stocks may be more attractive than bonds at current valuations, and we would recommend an appropriate overweighting of equities and an underweighting of fixed income securities to suitable investors.
Click here to download a PDF of this report.
This material is for general information only and is not intended to provide specific advice or recommendations to individuals. There can be no guarantee that the views or strategies discussed will be suitable for all investors or lead to positive results. The investment involves risks, including a possible loss of capital. The economic forecasts presented may not develop as predicted and may change.
References to markets, asset classes and sectors generally refer to the corresponding market index. Indices are unmanaged statistical composites and cannot be invested directly. The index performance gives no indication of the performance of an investment and does not reflect fees, expenses or sales fees. All stated performances are historical and do not guarantee future results.
All company names mentioned here are for educational purposes only and are not indicative of trade intentions or advertising for their products or services. LPL Financial does not offer investigations into individual stocks. All information is believed to come from reliable sources. However, LPL Financial does not guarantee the completeness or correctness.
All information is believed to come from reliable sources. However, LPL Financial does not guarantee the completeness or correctness.
The Standard & Poor’s 500 Index (S & P500) is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy by changing the overall market value of 500 stocks across all major industries.
The PE ratio (price-earnings ratio) is a measure of the price paid for a share in relation to the company’s annual net profit or profit per share. It is a financial measure used for valuation: a higher P / E means that investors pay more for each unit of net income, making the stock more expensive than one with a lower P / E.
The Forward Price to Earnings (Forward P / E) is a measure of the price-earnings ratio (P / E) using the forecast profit for the P / E calculation. While the earnings used are only an estimate and are not as reliable as the current earnings data, the estimated P / E analysis still offers advantages. The forecast result used in the formula can apply either for the next 12 months or for the next business period of the entire year.
All index data from FactSet.
For more information, see the full Outlook 2020: Bringing Markets Into Focus publication.
This research material was produced by LPL Financial LLC.
Investment and advisory services offered by LPL Financial (LPL), a registered investment advisor and broker-dealer (member FINRA / SIPC). Insurance products are offered through LPL or its licensed affiliates. To the extent that you receive investment advice from a separately registered independent investment advisor who is not an LPL partner, please note that LPL does not represent this company.
Not insured by FDIC / NCUA or any other government agency. No bank / credit union guaranteed. No deposits or bank / credit union commitments. May lose value
Tracking # 1-05014275 (Exp. 05/21)
Note: We are not the author of this content. For the Authentic and complete version,
Check its Original Source