We are entering earnings season, and it is tempting to say that Q2 2020 earnings will have massive significance. After all, we have a situation where the stock market is strong despite one of the weakest economies in decades. Surely something has to give, right? Either earnings have to indicate that reality is catching up with all the hype and hope, or stock prices must correct back to reflect the reality. The nature of the rally to this point, however, indicates that that is not necessarily the case.
Over the next few weeks, we will hear from the majority of S&P 500 companies on how their earnings continue to be affected by Covid-19 and the accompanying collapse in the economy. Highlights this week include the major banks, who will be reporting Tuesday, Wednesday and Thursday. We also have Delta Airlines (DAL) tomorrow, and Netflix (NFLX) on Thursday. Thursday will also see releases from other significant companies, such as Johnson and Johnson (JNJ) and the smaller but indicative JB Hunt Transport (JBHT).
All of that sounds extremely significant but the evidence suggests that, as upsetting as it is to those who believe that fundamentals matter, it really isn’t. Nasdaq is sitting around record highs and the S&P 500 is just six percent below its pre-pandemic highs. Corporate earnings, the most fundamental basis of stock valuation, has little or nothing to do with that.
The expectation, according to Refinitiv, is for Q2 2020 earnings to be down 44% from the same quarter last year. The S&P 500, though, is around 10% higher than it was in early August, following those 2019 releases. You might think that is all about optimism for a quick bounce back from the pandemic, but when it comes to analysts, you would be wrong. Some of the strongest gains came early last quarter, as earnings estimate revisions were running at a recession-level 80% negative, and the massive resurgence in Covid-19 cases have led some states to reverse re-openings, making a reversal of what economic bounce back we have seen so far a distinct possibility.
Those downward revisions mean that the most likely scenario for the next month or so looks to be that those cuts in estimates produce a situation where the usual two-thirds or more of companies exceed expectations for EPS. That will make the market climbs higher still, even as we witness a year on year decline of, say, 25-30% in actual profits, maybe some proactive dividend cuts, and almost certainly an increasingly murky outlook.
That murkiness will come if, as looks likely, increasing numbers of companies refrain from giving any guidance for Q3 and through the end of this year. How can they forecast results with any confidence with coronavirus surging so viciously in the U.S. and with over 10% unemployment? That should be a big worry, but the current market will look at it as a positive. Without the drag of depressing corporate estimates, traders and investors can continue to buy, telling themselves that the beat of estimates is what counts and that a vaccine really is coming any day now.
If you trace a hint of sarcasm, despair even, in my voice, you are correct. I am old fashioned enough to believe that things like corporate profitability, GDP growth, and unemployment matter. But the market has been ignoring weakness in the last two of those for months, so will presumably ignore weakness in the first as well.
Don’t be surprised then if, as company after company reports “beats” of estimates that amount to massive declines in earnings, the market powers on up. There is already evidence of that this morning. Pepsico (PEP) is up 2% in premarket trading after reporting earnings that beat estimates by 7 cents but were 18% lower than last year.
The relevant fact is that the federal government and the Fed are handing out cash to be invested, and little things like corporate earnings won’t get in the way of that particular express train. Until the government goodies cease, which is probably not going to happen before the election, that will continue.
So, as important as this earnings season looks like it should be, it probably won’t matter at all.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Martin Tillier
Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.
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