Earnings season: it will be bad, but will it be bad enough?

Earnings set for biggest decline since 2009

FactSet expects earnings to decline by 7.3 % for the upcoming quarterly reporting season, the worst decline since quarter three (Q3) 2009, when corporate earnings dropped by a remarkable 15.2%%.

But if corporate reporting season only shows a drop of 5%, then it may not drag stock prices much lower. Why? Well, stock prices are a function of future earnings, not the ones that have already happened.

From this point onwards, investors looking at stock markets, and individual companies, will want to know about the prospect of earnings in the rest of 2020, and even more importantly, into 2021 and beyond. It is impossible to forecast earnings with any degree of real certainty at the best of times, but it is even more acute now, when coronavirus has caused the closure of so much of the global economy.

It might seem odd to think about buying stocks at present, given that the future seems uncertain. But, and these are large caveats, if the situation begins to improve then stock prices, particularly in the US, will look more attractive. Usually, bear markets take time to develop, and economic data has already begun to deteriorate. Indeed, the actual recession tends to come towards the end of the bear market.

This time around, we have run into a bear market with unemployment at record lows (until the last two weeks of data), and retail sales at an all-time high. Stock prices were also at a record, and consumer confidence was strong. Thus the 2020 bear market is, currently, not much like the 2001 and 2007 examples, except perhaps for high valuations for equities. Following the roadmap for these two bear markets might not offer the most helpful course for investors.

Have markets got over the pandemic shock?

We already have a taste of how earnings season might go thanks to the recent run of economic data. This is moved into the ‘very bad’ column very quickly, with a record high level of US initial jobless claims, and non-farm payrolls weakening at a level not seen since the very depth of the financial crisis.

However, markets continue to rebound despite this poor data. This seems odd, but expectations for this data were already very low. And despite being very poor indeed, markets have seemed to get over the shock. This response has been predicated on expectations that, when lockdowns around the globe end, then we will see a strong rebound in economic data. A similar pattern can be expected for earnings expectations too, and for the market response.

The proof will come this time around, but in the coming quarters beyond this one. If shutdowns go on longer, and data keeps getting worse, then earnings will reflect this, and likely put further pressure on stock prices. But those hoping for another big move down thanks to earnings season will be, I suspect, disappointed. The bigger problem will be an intensification of infection and death rates, particularly in the US.