We are at the beginning of the reporting season for the second quarter, which is likely to be exceptional given the current situation. At the beginning of the year, the corona crisis was still a long way off and nobody expected a historic quarter in Q2 2020. However, the situation has changed drastically as a result of the pandemic and especially the lockdown in numerous countries. Although most regions were only affected by the crisis at the end of the first quarter, corporate balance sheets already showed clear signs of slowing down in Q1 and pressure on margins increased. Although companies in the S&P 500 index still reported positive sales growth of 0.8%, profits were down 15.0%. In Europe, where the corona wave started somewhat earlier, the companies in the Stoxx Europe 600 Index recorded a 3.4% decline in sales and 38.2% lower profits. While defensive sectors such as utilities, consumer staples and healthcare performed positively or even better than expected, profits in financial stocks and consumer durables fell even more sharply than forecast. As a result, the latter in particular suspended their outlook and also dividend payments in order to secure liquidity.
Negative earnings revisions at record level
Due to the changed environment and increased uncertainty, estimates for Q2 2020 were revised downwards by 37% during the quarter, with all eleven sectors, led by energy, consumer durables and industrials, showing signs of weakening. While it is normal for expectations to be lowered slightly ahead of publication, estimates have been revised downwards by an average of 3.2% over the past 20 quarters - never more than 10%. Even during the financial crisis, the correction was not as severe. Accordingly, corporate earnings in the S&P 500 are now expected to decline by 43.8%, the biggest slump since Q4 2008, with revenues estimated at -11.1%. The forecasts for European stocks in the Stoxx 600 index are even gloomier. Analysts even expect a decline of 18.6% in sales and 53.9% in earnings.
Decline in profits across all sectors
Positive revenue growth is expected for the healthcare and utilities sector, while the other nine are expected to see a year-on-year decline in revenues. Profits are forecast to decline in all eleven sectors, led by energy, consumer durables, industrials and financials.
Low visibility, high uncertainty
Q2 2020 is remarkable not only because of the expected sharp drop in earnings after the record-breaking earnings revisions, but above all because due to a high level of uncertainty combined with low visibility. A very large number of companies have withdrawn their outlook. For Q2 2020, 27 S&P 500 companies have published a negative and 22 a positive earnings forecast. The total number of groups that have issued an outlook for earnings per share is thus significantly below the average of 106 for the past 20 quarters. This is important because the outlook is an important point of reference for analysts and investors. Companies have perfected the system over the past few years and have managed each time to slightly exceed expectations. This means that analysts' estimates, which are currently burdened with a high degree of uncertainty, are the only benchmark, so that positive and negative surprises must be expected.
Evaluation already anticipates a lot
While Q2 estimates have been revised downwards at record speed, stock prices have risen significantly over the same period. We think investors should not over-interpret Q2 2020 results, because the value of a stock is not based on a quarterly result, but on all future earnings. Nevertheless, with current P/Es for the next twelve months of 21.8x for the S&P 500 and 18.3x for the Stoxx Europe 600, the market is already anticipating a lot and trading well above its own average historical valuations. In view of the liquidity injections by the national banks, this also seems justified.
Reported earnings could beat forecasts
As mentioned above, we expect that Q2 2020 could bring an above-average number of surprises given the estimates, which are burdened with high uncertainties. We think it is possible that, without guidance, the forecasts have on average been revised too much to be on the safe side and may not turn out to be quite as catastrophic. In any case, since the slump at the beginning of the quarter, when they were flying blind, the tone of companies has improved to cautiously optimistic as the pandemic progresses. At the same time, the negative earnings revisions have decreased again. Of the 17 S&P 500 companies that have already reported their Q2 2020 results, 14 have exceeded their earnings estimates. Q2 2020 will certainly bring more clarity about the extent of the earnings slump and thus reduce uncertainty. Assuming that there is no second wave, this should also mark the bottom of the cycle.
Companies will continue the practice of not giving an update on the outlook
Many market participants argued that the market will see through the Q2 2020 reporting season and it is less important how low profits are than how quickly they will recover. Therefore, the outlook will be almost more significant than the actual Q2 2020 results. At the moment, the decline in earnings is expected to ease gradually in Q3 2020 (-25.2%) and Q4 2020 (-12.7%) before returning to growth in Q1 2021 (+13.0%), also thanks to the base effect. Although companies have learned in recent months what effects the corona pandemic will have on their business performance and how they must deal with it, they will not be able to escape the effects of the crisis. However, given the still uncertain course of the pandemic, we expect that most of them will not be able to bring themselves to publish a new outlook. It is possible, however, that individual companies, once the worst appears to be over, may resume payment of suspended or postponed dividends if regulatory permits (which we do not expect European banks to do). Uncertainty about the shape of the recovery is likely to persist and only Q3 2020 will bring more clarity.