Earnings in the time of Covid: the dissonance of blowout profits

Muted stock price moves show optimism has been mostly priced in. Photo / AP

Lex OPINION:

Business appears to have shed all moorings to reality. Europe is plunging into a serious "second wave" of coronavirus. Yet record numbers of companies are beating profit expectations, with many upgrading earnings forecasts too. Some of the dissonance dissolves under scrutiny. A portion persists disturbingly.

Shell, BT and Lloyds, businesses worth £100 billion ($195b) in total, all exceeded third-quarter forecasts. Notably, the UK's largest high street bank was buoyed by surging mortgages and lower than expected loan loss provisions.

Bosses are trumpeting the resilience of their businesses in the wake of a grinding downturn. Lockdowns closed shops, pubs, restaurants, hotels and airlines, and may do so again. Measures of economic activity recorded their largest declines ever in the second quarter. Yet earnings for many big listed businesses have been robust.

The rock-bottom comparatives of the second quarter are only one reason for this. Crucially, government stimulus has boosted banks and supported consumer businesses not reliant on customer footfall. These include online retailers of clothes, groceries, takeaway meals and white goods. Investors who initially modelled an across-the-board blow to business have sorted stocks into winners and losers. A shaky K-shaped recovery has begun.

About one-third of large US and European listed groups have so far reported for the three months to September. In the US, about 90 per cent of those have so far exceeded analysts' expectations.

The number of "beats" and the sizes of the surprises are lower in Europe. Still, a majority of companies have produced earnings better than forecasts. Earnings will still be materially lower this year; by a fifth in the US and a third in Europe compared with 2019.

Muted stock price moves show optimism is mostly priced in. Shares of European companies beating expectations outperformed by just 1.2 per cent on the day, says Morgan Stanley. Those that were simply on target underperformed by 1.8 per cent on the day on average. Market reactions in the US have also been modest.

Earnings forecasts for the final quarter of the year are rising, as confidence returns. Downside risks are growing. Businesses initially overestimated spillover from badly damaged sectors such as travel and leisure. Some seem to imagine they are now immune from it, even as renewed lockdowns increase the chances of big corporate collapses. Government stimulus is fading. The fourth quarter of this year will yield fewer pleasant surprises.

© Financial Times