Schwab Market Perspective: Turning to Earnings Season
With economic momentum having slowed, investors likely will shift their focus to third-quarter earnings for clues about future market direction—although actual earnings numbers may be less important than what corporate leaders say about their expectations. Business leaders are more confident in their outlook than when they reported second-quarter results, according to global business surveys. Bond markets also have moved from cautious to optimistic over the past few months, as reflected in rising longer-term Treasury yields.
Can this optimism last? There are risks, of course, notably a potential resurgence in global COVID-19 cases. However, there are also reasons for optimism, which we discuss below.
U.S. stocks and economy: Economic momentum has slowed
As we enter the final quarter of the year, economic momentum has slowed from its summer peak. Some pockets of the economy have continued to hold up well—such as housing and retail sales, boosted by persistently-low rates and government aid, respectively. Yet other areas, such as restaurants and travel, have not given any indication yet of a pickup in growth.
Given that the bounce in activity off the extreme April lows is behind us, economic data relative to expectations—as measured by Citi’s Economic Surprise Index—have cooled. Put simply, actual reported data has come in below economists’ estimates, which contrasts with the spike earlier in the year when estimates were at extreme lows. As the chart below shows, we are still near record territory relative to history, but the pace is slowing.
Economic improvements and beats are slowing
Source: Charles Schwab, Bloomberg, as of 10/14/2020.
Investors may begin to shift focus to corporate earnings. S&P 500 earnings growth is picking up as profits move off their crisis lows amid companies benefiting from pent-up demand. While we remain in an earnings recession, forward estimates continue to improve. As you can see in the chart below, growth is expected to turn positive in 2021.
An earnings recovery is on the horizon, but there are caveats
Source: Charles Schwab, I/B/E/S data from Refinitiv, as of 10/15/2020. For illustrative purposes only. Past performance is no guarantee of future results.
There are caveats to earnings’ presumed strength—one being the simple fact that year-over-year comparisons will be “easier” next year. Given the abrupt plunge in the economy during the first and second quarters of this year, the slightest rebound in activity and profits during the same period in 2021 will boost growth rates markedly. That assumes we return to an environment where demand comes back and profits along with it—which is not guaranteed given the virus’ unknown trajectory from here.