Running on Faith: Are Stocks Discounting Too Powerful an Earnings Recovery?

Key Points

  • 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.

Blind analysts

Thanks to the grave uncertainty unleashed by the pandemic, nearly half of S&P 500 companies have withdrawn full-year earnings per share (EPS) guidance; so analysts have been flying a bit blind during the pandemic.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.