Running on Faith: Are Stocks Discounting Too Powerful an Earnings Recovery?
We are in the heart of second quarter earnings season, with the “beat rate” above average thanks to an extremely low bar.
Stocks’ substantial run since the March lows has been P/E-driven, not EPS-driven.
Concentration, courtesy of the “big five” represents potentially-significant risk; but there are fundamental differences between 2000 and 2020.
About 130 of the S&P 500’s companies have reported second quarter earnings, and while weakness has shown itself in a few areas of the stock market; in general, earnings season has been better-than-expected. But we shouldn’t conflate better-than-expected with strong. Yes, 80% of companies have beaten analysts’ expectations (as per Refinitiv); but the expected decline in earnings for the second quarter is currently -40% (representing the blend of actual results for companies having reported and expectations for subsequent reports). A lesser 68% have beaten revenue estimates. You can see historical/current/future earnings growth rates in the table below; also broken out by S&P 500 sector.
Source: Charles Schwab, I/B/E/S data from Refinitiv, as of 7/27/2020. For illustrative purposes only.
Thanks to the grave uncertainty unleashed by the pandemic, nearly half of S&P 500 companies have withdrawn full-year earnings per share (EPS) guidance; so analysts have been flying a bit blind during the pandemic. With analysts having lowered their estimates to a significant degree, the spread between the percentage of companies that have raised guidance and lowered guidance this season (through Friday) is currently at +10 percentage points (as per Bespoke Investment Group). The rub is that with the escalating economic damage from COVID-19’s resurgence, the ascent of forward guidance could falter.
In terms of valuations, the significant move up off the March 23 S&P 500 low has been a P/E-driven surge; not an earnings-driven surge. From a recent low of 13.1 on March 23, the forward P/E for the S&P 500 has surged to 21.5. That is getting eerily close to the P/E highs of the late-1990s into the market’s bubble peak in 2000, as you can see in the chart below.
Forward P/E’s Ascent
Source: Charles Schwab, FactSet, as of 7/24/2020.