Q2 Earnings Preview — Depressing Numbers Ahead?
The first-quarter earnings performance had been mixed, with most economic sectors underperforming and some companies on the brink of bankruptcies (Hertz International and LATAM Airlines are notable figures). The rise of work-from-home activities due to the COVID-19 pandemic led to the upswing of Zoom, Microsoft Teams, and Slack, leading to a concentration of capital into tech and healthcare, the industries that benefited the most from the biggest global issue since the WWII.
As most analysts predicted, the superstars of the first quarter had been the technology behemoths, starting with the FAANG group (Facebook, Amazon, Apple, Netflix, and Google), since the market participants bet on the companies performing well before the coronavirus crisis emerged.
With strong revenue, above-average profit margins, and healthy balance sheets, these stocks had risen, mainly due to multiple expansion, but the overall market confidence had been and continues to be in favor of big tech names.
Preview of Q2 earnings
Although the first quarter had been very good for the above-mentioned companies, the preliminary projections for the second quarter will not be so generous. Unemployment figures spiked past Those of the 2008 financial crisis, companies close or at least reduce volume, investment budgets disappear, research and development go bust, and consumers become increasingly conservative with their spending.
The macroeconomic data in the United States fully supports the picture above, despite a recent pick-up in economic activity, due to the removal of the lockdown. With the unemployment rate at 13.3% and the Atalanta Fed GDPNow estimate for the Q2 at -45.5%, companies are expected to publish depressing figures. Analysts at Goldman Sachs say the GDP will fall by approximately 34% this quarter, painting a dire picture that could get nasty for most S&P500 members.
In a research paper released by FactSet, the Q2 estimated earnings for the S&P500 reach is 43.4%. If the actual number will follow the prediction, it will mark the most significant year-on-year decline in earnings reported by the index since the last quarter of 2008, when the figures pointed to a staggering 69.1% contraction. On a per-share basis, estimated earnings for the second quarter have decreased by 35.9% since March 31st.
Major US indices to perform poorly?
Since the March selloff, all three US indices rebounded sharply from the lows, led by an accumulation of capital into large-cap shares and multiple expansion. The Nasdaq is close to new record highs, the S&P500 reached 3,200 a week ago, while the Dow Jones is the worst performer of the three, due to industrial and banking stocks that are part of the index.
Markets had gone up while earnings expectations had decreased substantially, mainly led by aggressive interventions from central banks. Fundamentals did not matter in the past few months but market participants could rethink their approach once the Q2 earnings will start to be released in July.
Since expectations are so negative, it is very likely that most investors will focus on a 4-pillar aggregate:
- Cyber-security companies
- Collaboration & conferencing products
- FAANG stocks
- Automation companies
Summary
As the coronavirus pandemic continues to act as a drag on economic activity, Q2 earnings will very likely be the worst since the 2008 financial markets. This could set a dangerous path for the markets in the next two months, as the current valuations will need massive earnings outperformance to be sustained.
With unemployment elevated, income and spending dropping, companies will report weak revenues and EPS, while also adjusting their forward guidance negatively. A second wave of the pandemic will delay the economic recovery and keep business conditions depressed. Despite massive liquidity available in the market, solvency issues could be a game-changer and make investors reconsider their overly optimistic view on stocks.
