The strangest earnings season in history
Markets move on information and going into this earnings season, they were woefully short. Largely due to the unknown impacts of the Covid-19 pandemic, the number of S&P 500 companies issuing earnings-per-share (EPS) guidance by quarter-end was 54% below the 5-year average—37% didn’t provide any. Disagreements among analysts added to rising EPS-estimate dispersion. About the only agreement was it was going to be awful. Consensus forecasts had Q2 earnings plunging 45% year-over-year (y/y)—the largest drop in 12 years, at the height of the global financial crisis. Although it’s very early, earnings so far are surprising positively. With 13.4% of the S&P market cap having reported, earnings have exceeded estimates by 13% in aggregate, the most since Q1 2010, with 75% of companies beating their lowered projections. It appears analysts overestimated the downside risks from Covid in contrast to the global financial crisis when they underestimated the risks. Jefferies notes analysts are now raising estimates and target prices—a trend that could get an additional lift if dollar weakness continues. Its recent decline is an endorsement of “Rest of World” strength, Evercore ISI says, and is helping further ease global liquidity, foster faster global industrial and investment growth, and support a rally in energy and other commodities.
The S&P has been in a range since late May, rallying on positive macro surprises or news on potential medical breakthroughs and slipping on bad news such as surging Covid cases. Leuthold believes this asymmetric response reinforces the more technical read that equity positioning is still low, making it more likely the market reacts positively to “good” Q2 earnings news. It sees potential for above-average beats, in large part because estimates continued to flat-line last month despite positive macro surprises. This suggests analysts continue to be very cautious due to spiking Covid cases, even though their resurgence occurred too late in Q2 to hit earnings much. Many attribute the market’s bounce since late June to accelerating consumer spending, housing strength and improvements in manufacturing (more below). JP Morgan forecasts consumer spending to return to pre-pandemic levels in the second half, when it expects 20% annualized GDP growth. China could be instructive. After contracting 6.8% in Q1, annualized GDP growth there rebounded to 3.2% in Q2 as reopenings and loosened restrictions occurred without Covid flare-ups—an outcome opposite to that in the U.S. so far. Still, even as Covid cases have shot up in populous Sunbelt states, equity prices have run up on what Jefferies believes to be the financial market’s version of the Venturi effect, when the flow of liquid or gas accelerates through an opening. Money is being forced into risk assets at astonishing speed, fed by cash from every direction—the Fed, with its highest level of money supply since World War II; the money markets, which have accumulated more than $1.4 trillion since February; and individuals, who have a big pile of savings as their options to spend have been limited by shutdowns and shelter-at-home. This liquidity is helping equities bounce well above rebounds off previous lows (1982, 1987, 2003 and 2009).
As Covid uncertainty swirls, investors are looking past this year to blended 2020-21 earnings, a stance that could benefit cyclical value stocks if the recovery takes hold. These include beaten-down large caps in the Consumer Discretionary, Industrials, Financials and Energy sectors. Value cyclicals and small caps have been leaders of late, while mega-cap tech stocks have fallen back. It is extremely hard for the S&P to hold up when “Big Tech’’ is in decline. But, importantly, market internals—not just cyclical stocks but copper and other industrial commodities—are signaling risk-on. Small-cap breadth was the strongest in two months on Wednesday, with the Russell 2000 outperforming the S&P by more than 2 standard deviations. Equal-weight Consumer Discretionary vs. Staples also surged. Strategas Research sees this as evidence of improving risk appetite. When I was young, I thought I’d be a psychologist one day. People are crazy, fascinating, and I thought I could help. It wasn’t meant to be, as I scored poorly in Science classes. Now, this week’s calls had me showcase my behavioral finance presentation to advisors and my market outlook to retail investors. An advisor shared his frustration with clients who wouldn’t admit to, or lied about their biases, and the trouble that brewed later. I shared my CIO’s view that we really have to be armchair psychologists in this business. Later, on a client call, an actual psychologist (jealous!) shared her perspective. These are strange times indeed, and her wise advisor suggested that we “focus on what we can control, not on what’s out of control.” Amen!
- Working on a V-shaped recovery Retail sales shot up again in June, easily topping consensus, and Cornerstone Macro’s proprietary survey of consumer confidence hit post-Covid highs. Jefferies’ monthly consumer survey found 60% back at work and 20% more expect to be back this summer. A significant number have visited personal care and apparel shops, and more than half have frequented a restaurant. While still down 10% y/y, industrial production jumped in June by the most since 1959, led by a doubling in vehicle output. New York and Philly Fed surveys indicate this improvement carried over into July. And June’s CPI report showed there really is no inflation to speak of.
- Housing on a tear The pandemic, and policy responses to it, have caused mortgage rates to plunge and shrunk supply as sellers have delisted homes. Pending sales are now back to pre-crisis levels, home prices keep rising, June housing starts and permits jumped, and July builder confidence soared to near yearly highs.
- Small business hires most of us … Small business optimism jumped again in June, putting it above 100 for the first time in four months. The NFIB gauge had plunged in March by the most in its history, ending a record 39-month streak of strong optimism (readings above 100). Its increase in sales expectations was a 99th percentile event—a move that historically has been a bullish marker for small-cap stocks.
- … but not enough for getting rehired Weekly jobless claims barely declined—first-time claims are running at a whopping 1.3 million, a sign layoffs are still happening—and continuing claims remained elevated. This suggests the job market will be the biggest impediment to recovery, especially if the “benefits cliff’’ isn’t resolved. Cowen thinks Phase 4 negotiations will be choppy, carry over to August and total about $1 trillion, cutting supplemental weekly jobless benefits in half to $300 but providing a new round of $1,200 stimulus checks.
- The market tends to inflict the most pain on the most people So TIS Group reminds us as it cites a Bank of America fund manager survey showing tech stocks to be the most crowded trade in survey history. This week saw an intraday reversal that took the Nasdaq 100 from a 2% gain to a 4% loss, a 98th percentile event. This eerily echoes the index’s behavior on March 7, 2000. Although it went on to hit a cycle high of 4,816 17 days later, it entered a bear market that didn’t bottom until October, 2002 at 795!
- More eerie stuff The huge rally after 9/11 did not get the Investors Intelligence poll to extreme optimism—but this spring’s rally did. Ned Davis said this and other data that shows small investors to be very bullish, putting sentiment/ valuation close enough to what one would see at bear-market rally tops.
At these yields, 6% looks pretty good With the 10-year Treasury yield under 0.70%, Goldman Sachs puts the odds of equity outperformance relative to bonds at 90% through 2030 and estimates the S&P will deliver an average annualized total return of 6% during the next 10 years.
The death of ‘Brand China?’ The U.K.’s U-turn on Huawei shows how international distrust of China is hardening. Canada’s relations with China have been in a deep freeze since Beijing responded to its arrest of Huawei’s CFO by detaining two Canadians, and India is on the verge of making a strategic reorientation toward the U.S. The deteriorating relationship between the world’s two most populous countries threatens the Covid response, Gavekal Research says, as India is the leading bulk producer of treatments and vaccines but relies on China for up to 70% of raw ingredients. A Deutsche Bank survey finds 41% of Americans and 35% of Chinese say they won’t buy each other’s products.
Who remembers the ‘Four Horsemen?’ Back in the late 1990s, four mega-cap tech stocks led the Nasdaq Composite to its all-time high in 2000—Microsoft, Intel, Cisco and Dell Computer. They were known as the Four Horsemen because of their unquestioned market dominance, and early on they led the euphoria over internet-related stocks that fueled the dot-com bubble. Nearly three years later, the S&P had lost half its value. Sentiment is starting to become as euphoric as the late 1990s, so ….