What we have learnt so far from US second-quarter earnings

American Airlines executives noted on their earnings call that much of the crisis was 'not just that demand is low - but that there is such uncertainty about it'. Photo / AP

COMMENT:

Two weeks into the US corporate earnings season and three important lessons have emerged.

First, Wall Street may have been too gloomy going into the results. Second, companies seen to be prospering under the pandemic will be flogged if their numbers disappoint. And third, uncertainty over coronavirus has made it hard for businesses to say very much at all about the future.

The bar is certainly low. In aggregate, S&P 500 companies are projected to report a 43 per cent plunge in profits for the second quarter and a 10 per cent drop in revenues, according to FactSet, the data provider. The net profit margin for companies on the blue-chip index is slated to come in at 7.3 per cent — the lowest since the final three months of 2009.

The grim forecasts reflect the damage wrought by the pandemic. Companies' outlooks soured as lockdowns brought travel to a standstill, closed businesses and pushed the US jobless rate to 14.7 per cent in April, the highest since the second world war.

While companies reduced payrolls in response to quarantines, many struggled to cut a number of fixed costs, such as lease expenses, and had to spend more to enable remote working or allow social distancing and deep cleaning to keep their staff and customers safe.

So far, however, numbers have generally come in brighter than expected — perhaps reflecting the effects of unprecedented stimulus from Congress and the US Federal Reserve. As of Thursday evening, almost four-fifths of the S&P 500 companies that had provided quarterly updates had posted earnings per share that were above analysts' expectations and, in aggregate, were reporting earnings 13 per cent above estimates, according to FactSet. Both those numbers are better than the five-year averages.

Andrew Slimmon, a managing director at Morgan Stanley Investment Management, noted that many economists had revised their growth estimates upwards in recent weeks — while analysts covering companies had not. That disconnect "tells me there is a good chance earnings season will be better than expected", he said.

Still, investors are primed for disappointment. Pandemic winners that benefited from people working at home, dining in, ordering online and spending more time on social media, are most likely to be punished in the event of a poor quarter or outlook. So, too, are mega-cap stocks that have driven the gains in the broader market. Cases in point: Netflix and Snap.

Netflix shares, which climbed almost 60 per cent between the beginning of lockdowns and the streaming service's results last week, fell 6.5 per cent after it warned that its pandemic-related growth spurt was slowing.

Meanwhile Snap, whose shares had more than doubled since the start of the pandemic, tumbled 6 per cent the day after the social media group said the boost it had received during lockdowns had "dissipated faster than we anticipated" and warned of headwinds in the current quarter.

"High valuations suggest fragility and vulnerability to surprises," said Katie Nixon, chief investment officer at Northern Trust Wealth Management. "So there is the potential for a more aggressive reaction," she added.

It is still early days, with about a fifth of S&P 500 companies having reported results so far. And with so many variables to weigh, such as Covid-19 case counts, a possible vaccine and additional fiscal and monetary stimulus, investors are likely to fasten on to hard items such as cash payouts.

Dividend payments, for example, were down a net US$42.5 billion ($63.9b) in the second quarter from the same period a year ago, the biggest such decline since the financial crisis, according to Howard Silverblatt, senior index analyst at S&P Dow Jones Indices.

"Maybe what is important this earnings season isn't earnings; maybe it's dividends," said Jeff Kleintop, chief global investment strategist at Charles Schwab. He noted that many investors are looking for the income that they are not getting in the bond market.

Outlooks will also be vital. More than one in three S&P 500 companies have formally withdrawn their EPS guidance for 2020, so executives providing steers on profits will be "the key thing" that the market is going to respond to, said Seema Shah, chief strategist at Principal Global Advisors.

But clarity is hard to come by. American Airlines executives noted on their earnings call that much of this crisis was "not just that demand is low — but that there is such uncertainty about it".

Banks were wary too. Instead of celebrating a trading boom, they made huge provisions for current and future loan losses and warned that things could get worse. "We don't know what the future is going to hold," said Jamie Dimon, chief executive at JPMorgan Chase. Citi chief Mike Corbat described a "completely unpredictable" environment.

"It's very hard to lay a road map for the future," Nixon said. "The cautious tone from banks . . . that was uncertainty with a capital U."

Written by: Mamta Badkar

© Financial Times