The second quarter results season started in earnest this week and expectations in the market are low after a bruising few months for most companies due to the Covid-19 pandemic. But the uniformly grim forecasts mean that the probability of beating them is high, which would mean further support for the ongoing recovery narrative.
First the bad news. Second quarter earnings for the S&P 500 are expected to drop 45% year on year and to be down 59% for the STOXX Europe index. These declines will be led by the energy and consumer discretionary sectors with industrials taking the third worst slot. At the other end of the spectrum only US utilities are expected to register earnings growth on a year on year basis. Even the IT and healthcare sectors are expected to deliver low double-digit declines in earnings.
Sales expectations are not any more positive. For the S&P 500 Sales are expected to decline 11.5% versus last year. The equivalent figure for the Stoxx Europe is 18.6%. However, sales growth is expected for the utility and healthcare sectors with IT close to flat.
Now for the good news: with such terrible forecasts the probability for beating them is high. There has been little change to Q2 forecasts over the last month which is unusual coming into a reporting season. This combined with a low bar for the out-turn should yield a relatively good relative result against expectations.
However, a better-than-expected earnings season would not come as a surprise at this stage. It would be more a reassurance about the recovery we already see in the economic data, rather than a new reason for markets to drive higher.
Finally, we’ll be paying close attention to the commentary around results. Commentary could turn out to be more upbeat, or at least not gloomy. The corporate sector finished the quarter on a strong month so this may inspire a calmer reflection in the outlook statements.
For a sense of how things might go, it is worth looking at the banking sector. It is early in the earnings season with mainly the large US banks reporting so far. Their earnings remain depressed due to high levels of loan loss provisions. There is some optimism that earnings remain positive for most banks despite the current situation. The loan loss provisions are only estimates of what will happen as insufficient time has elapsed to see much of the expected increase in bad debts. Fiscal policy has also been very supportive of borrowers to date. Nonetheless, the projected losses have increased since Q1 results as the underlying economic conditions are now expected to be worse than assumed in March. Some of the banks have reported very strong results in their capital markets divisions but expectations are that these will moderate. Overall, the outlook commentary has been cautiously optimistic that the worst point for the economy has passed, but the future remains highly uncertain based on the known virus-related risks to the economic recovery.