What are earnings forecasts telling us about the recovery?
Two weeks ago, we discussed whether a fresh wave of COVID-19 cases could derail global economic recovery. Our conclusion was the recovery momentum could be hindered by new outbreaks and the need to reimpose social distancing measures. However, it is unlikely for the global economy to revisit the April/May lows, given ample government fiscal stimulus and accumulated experience by governments and companies to limit the impact.
Subsequent economic data releases confirmed the improvement in the global economy. Both the global manufacturing and services Purchasing Managers’ Indices rebounded to above 50 in July. China’s exports grew 7.2% year-over-year in July, significantly outperforming expectations. The U.S. job market generated 1.76 million new jobs in July, with the jobless rate falling to 10.2%. This was also stronger than expected.
In addition to economic data, it is also worth taking a look at corporate earnings expectations, especially in the U.S. as we approach the end of the 2Q earnings season. 86% of the S&P 500 companies have reported their earnings. 77% of companies beat their earnings forecasts and 66% beat their revenue forecasts. Net income is down by 32% for the companies who have reported so far, compared with 43% contraction expected before the earnings reporting season began. The healthcare, technology and utilities sectors were, unsurprisingly, able to maintain positive earnings growth in 2Q, which is generally seen as the worst hit quarter by the pandemic. Consumer discretionary, energy, and industrial were the worst hit sectors. Given the better than expected earnings reports, analyst consensus for 2020 earnings per share (EPS) growth has been revised higher from -23.5% to 20.4%.
At the moment, analysts are expecting corporate earnings to expand by 20% in 3Q 2020, compared with 2Q, and then ease to 12% in 4Q. Although this seems to be a very aggressive rebound in net income, 4Q 2020 EPS would still be 13.5% lower than before the pandemic in 4Q 2019. Consensus forecasts suggest that we may not make full recovery until the end of 2021.
It is important to reiterate that while the growth rate of economic activity and earnings could go through an encouraging surge in 3Q and fit in with the “V-shape rebound” narrative, this momentum could wane going into 4Q. Meanwhile, the level of activity and profit would take much longer to revert back to normal. Vaccines or other medical solutions to help restore life to pre-pandemic will be critical for the next stage of recovery.
EXHIBIT 1: CORPORATE EARNINGS
One can argue that analysts are forecasting a relative smooth recovery in corporate earnings between now and the end of 2021. This is subjected to near-term uncertainties, such as the ongoing U.S.-China tension and the upcoming U.S. presidential and congressional elections. Hence, we still think a well-globally-diversified portfolio of equities and fixed income would make sense to mitigate the geopolitical risks. For fixed income, corporate credit and emerging market fixed income are still in a strong position to benefit from the low yield environment.
In the longer term, the development and distribution of vaccines would be key for the next stage of recovery. Positive progress in vaccine development could boost the strongest companies amongst the worst hit sectors during this pandemic. This is because fiscal stimulus could gradually be withdrawn as the pandemic becomes under control, but it could take longer for these sectors to make full a recovery. Hence, the stronger companies are likely to be in a better position to survive, as well as seek out acquisition opportunities to expand for the future.