Mon, 10/12/2020 – 14:31
This week’s earnings aside, Goldman’s David Kostin over the weekend minimized the importance of Q3 earnings for the broader market, which he listed as third in order of importance behind a Covid vaccine and the elections. There is a reason why the Goldman strategist may want to minimize the importance of the next 4 weeks, because as he admits, the consequences of the semi-frozen economy on an uneven road to recovery will be visible in 3Q results: consensus expects 3Q S&P 500 EPS will decline by 21% on a year/year basis, following a 32% drop in 2Q and a 15% fall in 1Q.
Including the anticipated 14% fall in 4Q, Goldman’s full-year 2020 EPS estimate of $130 reflects a 21% year/year decline from the 2019 level, which also means that Goldman is using a 28x PE multiple to get to its year-end S&P target of 2020. Which, frankly, is hilarious and is only made possible by the Fed’s constantly manipulation of the so-called “market.”
In keeping with the K-shaped recovery theme, it will be a story of two earnings seasons: one for the giga caps, and another for everyone else. Consider this: the 5 largest S&P 500 stocks – AAPL, MSFT, AMZN, GOOGL, and FB – are expected to grow 3Q sales and EPS by +13% and +1%, respectively, compared with -5% and -24% for the rest of the S&P 500. The disparity is even more apparent across indices. While S&P 500 EPS is expected to fall by 21%, consensus forecasts earnings for the small-cap Russell 2000 index will fall by 40%
Drilling down in the coming earnings report, Goldman sees three themes characterizing results across most sectors.
- First, a collapse in margins, with aggregate index-level margins compressing by 220bps on a Y/Y basis to 8.7%. For context, although the margin decline n 3Q will represent a slight improvement from the peak pandemic decline in 2Q (-223 bp to 8.6%), it will still register as the lowest level of margins since 2010.
- Second, the modest 3% decline in aggregate sales will mask the bi-modal story beneath the surface. Cyclical sectors will suffer sharp revenue declines led by Energy (-32%). In Industrials, a 15% fall in sales will lead to a 62% plunge in EPS as the sector suffers from elevated operating leverage. Banks earnings are expected to decline by ~25% as pre-provision net revenues continue to deteriorate, despite smaller expected reserve builds. In contrast, Health Care (+5%), Consumer Staples (+4%), and Info Tech (+3%) are expected to post positive sales growth. As usual, large-cap stocks are better positioned for 3Q than small-cap stocks. Investors have exhibited a preference for size in 2020 with the S&P 500 climbing by 8% YTD vs. -1% for the Russell 2000. And, as noted above, while S&P 500 EPS is expected to fall by 21%, consensus forecasts earnings for the small-cap Russell 2000 index will fall by 40%
- Third, most managements will still be reluctant to provide forward earnings guidance. According to Factset, around 52% of the 285 companies that have historically provided EPS guidance stated that they were not providing EPS guidance or confirmed a previous withdrawal of EPS guidance for either FY 2020 or FY 2021. Almost all of these companies cited the uncertainty of the future economic impacts of COVID-19 as the reason for not providing or withdrawing EPS guidance for the full year. At the sector level, the Consumer Discretionary (33) and Industrials (27) sectors had the highest number of companies withdrawing or not providing annual EPS guidance. On the other hand, 138 S&P 500 companies provided EPS guidance for FY 2020 or FY 2021. Of these 138 companies, 59 provided annual EPS guidance that was higher than the previous guidance issued by the company, 41 maintained previous (annual) EPS guidance, 26 provided annual EPS guidance that was lower than the previous guidance issued by the company, and 12 initiated annual EPS guidance (no prior guidance issued). At the sector level, the Health Care (31) and Utilities (26) sectors had the highest number of companies issuing annual EPS guidance. According to Goldman, “the uncertain timeline of a vaccine that is essential for the normalization of the economy, the stalled talks between the Trump administration and Congress on an interim fiscal package, and the contentious election that is only 25 days away are all valid reasons for executives to minimize forward-looking commentary.” However, consensus 2021 EPS estimates have recently troughed and started to turn positive.
Alongside Goldman, Deutsche Bank has also published its own earnings forecast, which has a slightly more upbeat tone to it: As DB’s Binky Chadha writes, Q2 reporting season saw S&P 500 earnings beat at an unprecedented rate (granted these were beats to extremely pessimistic estimates) both in terms of breadth (85%) and size (+20%), prompting historically rare, strong upgrades to forward estimates, especially for the cyclicals, and one of the strongest earnings season rallies on record.
And while the bottom-up consensus for Q3 is for a “sharp” rebound in headline earnings, the bulk of it is being driven by reductions in loan loss provisions and Energy sector losses. Excluding these, underlying earnings growth is forecast to barely move up (-15% to -13%), despite rising Q3 GDP growth estimates pointing to a strong macro rebound. This to Chadha suggests the consensus is likely again underestimating the bounce in earnings and, if so, “the question is whether the market will rally on above-average beats or election uncertainty will cap gains.”
Below are some more observations from the Deutsche Bank chief strategist:
- “Q3 marks the beginning of a rebound in earnings. The bottom-up analyst consensus now sees S&P 500 EPS growth rising from -32.6% yoy in Q2, which was the worst since 2008-09, to -18.6% in Q3. The improvement in growth is being driven by both sales (from -9% in Q2 to -4% in Q3) as well as margins (-273bps in Q2 to -171bps in Q3).”
- Wide variation in growth across stocks and sectors persists. Similar to the last two quarters, median company growth is running significantly above the headline aggregate, pointing to the impact of large outliers.
- Cyclical industries (-67% to -41%) are expected to continue to see steeply negative growth, driving almost all of the aggregate decline in S&P 500 earnings, while earnings for the defensives (-1.5% to -3.2%) are expected to be down only slightly, and for the Mega-Cap Growth and Tech stocks (-3.7% to +1%) to in fact be slightly up.
- Growth expected to continue moving higher but remain negative next quarter, before turning positive in 2021. The consensus sees growth moving up further in Q4 (-13%), turning positive in Q1 2021 (+12%) and surging in Q2 2021 (+45%) due to base effects. Consensus estimates for 2020 ($130) and 2021 ($167) have been creeping higher but we see room for them to rise further.
- The bulk of the sharp rebound in consensus estimates is being driven by reductions in loan loss provisions and Energy sector losses. Much as in Q1 and Q2, aggregate S&P 500 growth in Q3 continues to be disproportionately impacted by movements in loan loss provisions by the Financials and Energy sector losses.
- Loan loss provisions, which tend to be lumpy and front loaded, are expected to fall from $53bn in Q2 to $22bn in Q3, adding almost 9pp to S&P 500 growth. A bounce in oil prices has meant a smaller drag from Energy sector losses in Q3, helping overall S&P 500 growth rise by almost 3.4pp. Together, these two drivers account for more than 12pp of the 14pp rise in consensus S&P 500 earnings growth from Q2 to Q3.
- Underlying earnings growth is forecast to barely move up in Q3. Growth excluding the impact of loan loss provisions and Energy losses, which DB claims “is a better indicator of underlying growth”, is forecast to barely move higher in Q3, from -15% to -13%. This reflects consensus factoring in very little for a fundamental recovery in growth.
- Q3 GDP growth estimates on the other hand have been moving steadily higher and are for a very strong rebound. Reported macro data has continued to surprise to the upside and in turn consensus GDP forecasts for Q3 have been rising steadily for the last 6 months and now stand at +25.3% (qoq ar), compared to -31.4% in Q2. DB’s economists see Q3 growth coming in higher, at +31.8% and tracking estimates are running even higher (+33.3%).
- Meanwhile, Q3 EPS consensus estimates have been rising since the Q2 earnings season…
… but have lagged the improvement in GDP estimates, suggesting room for strong beats as well as upward revisions.
Finally, early reporters have posted large beats so far. While only a handful of companies have reported Q3 earnings so far (19), almost all of them have beat estimates (18), with the aggregate beat running at 20% (median 14%).
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Author: Tyler Durden