The U.S. economy, despite facing a sharp decline during the first half of the year, grew by an annualized rate of 33.1% in the third quarter, the strongest quarterly performance on record. This was largely driven by an increase in demand for consumer goods and an increase in manufacturing activity. Corporate earnings in the U.S. have also rebounded nicely. However, the strong momentum seen in the third quarter might be short-lived, given the high level of uncertainty of what lies ahead.
Approximately 83% of companies beat earnings estimates in the third quarter. Although earnings are still down marginally year-over-year, when compared to the figures for the first and second quarter of -49% and -33%, respectively, a strong economic recovery in 3Q is evident. It is also promising to see that companies are becoming increasingly confident about the outlook and resuming their provision of guidance, after a lack thereof earlier this year.
Despite many earnings beats this quarter, there has been a muted response from markets, which has eroded a traditional well-known opportunity for alpha. Therefore, it is reasonable to assume that these outperformances were already priced in and are likely being overshadowed by the market reacting to the uncertainties around the pandemic and potential decline of 2021 earnings projections. Also from a profit standpoint, only four of the eleven Global Industry Classification Standard sectors – consumer staples, technology, health care, and utilities – are expected to see positive earnings growth on a year-over-year basis. The remaining sectors are generally expected to post double-digit declines and earnings in these sectors may continue to suffer if a vaccine surfaces later than expected.
On the COVID-19 front, the U.S. is facing all-time highs in new daily cases with over 100,000 per day. Europe has reintroduced lockdowns to grapple with the resurgence of the pandemic and we may soon see the U.S. follow suit. The magnitude of the second wave and whether it will cause Europe and the U.S. to tumble into another recession remain unclear, especially given the optimism surrounding a potential medical solution. That said, it is important to note that even if there is an effective vaccine introduced, it will still take time to administer it on a large scale and eradicating the pandemic will likely be a game of catchup to the rising cases around the globe. Furthermore, investors have been hoping for a stimulus package to transpire out of Washington, but with the recent elections likely resulting in a divided government, any fiscal stimulus package would likely be of a much smaller scale than the USD 2.2trillion that the Democratic party initially demanded.
Exhibit 1: 3Q 2020 Earnings results
Source: FactSet, Standard & Poor's, J.P. Morgan Asset Management. Data available as at 13/11/2020.
Investment implications
There are many uncertainties ahead and while U.S. corporates had a solid earnings season, global COVID-19 cases continue to rise. We may see the global recovery halt and the economy veer off course if the magnitude of the second wave is larger than expected. As markets continue to speculate on the timing and effectiveness of both a vaccine and a fiscal stimulus package, a balanced approach to investing is highly recommended.
Value currently seems attractive relative to growth and should outperform as economic activity picks up and inflation expectations rise. That said, we also like the structural long-term trend of growth, particularly in technology, healthcare and communication services.
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