Q2 earnings season came and went with very little fanfare. Of course, most financial and other news coverage seemed to be focused solely on the Covid-19 outbreak, unemployment data, politics-as-usual, and fiscal and monetary stimulus. From what I could gather, earnings were barely mentioned at all. But they should have been.
Long-time readers of my column know how much emphasis I place on earnings as a long-term driver of stock prices. If a company consistently grows earnings and frequently exceeds expectations in the process, the stock will almost certainly do well. If you made the argument that the three most important words in equity investing are “better-than-expected,” I’d probably agree with you.
That’s why it is meaningful that earnings were barely mentioned in the news. Even though earnings took a huge hit in Q2 – total earnings (or aggregate net income) for the 458 S&P 500 members that have reported are down -35.4% on -11.3% lower revenues – corporations largely performed better than most analysts and even CEOs expected.1
As I write, 79.7% of reporting companies beat consensus earnings-per-share estimates and 62.9% beat revenue estimates. On a blended basis, 55.7% of companies exceeded expectations, which represents a very strong showing relative to recent history:2
To be fair, analysts were totally in the dark as they set their Q2 earnings-per-share and revenue estimates. As we all know, most companies withdrew previously issued guidance given how difficult it was project business trends during the period because of the pandemic. Everyone was venturing into the unknown.
In my view, however, the tendency to assume worst-case scenarios led to analyst and CEO projections that were far too dire. When the ‘worse than the Great Depression’ forecasts did not materialize, stocks rallied. This is often how markets work.
Importantly, the realization that the economy and corporate earnings outlook may not be as bleak as expected is extending to the current period (Q3 2020) and beyond. As you can see in the chart below, Q3 earnings growth estimates for the S&P 500 index have been gradually improving week to week, getting better in tandem with a slowly – but steadily – improving economic growth picture since the start of July. We have been seeing a similar trend take place for Q4 2020 and full-year 2020 estimates as well.
This is a notable improvement in the overall earnings picture since the start of the pandemic, and is in-line with high-frequency macroeconomic data showing a similar improvement in the economy’s growth drivers. Recent readings in retail sales, initial jobless claims, and factory activity have all shown steady momentum. Again, the point is not to say the economy is humming again – it isn’t. But are the economy and U.S. corporations holding up just slightly better than many anticipated? I think the data above suggests the answer is yes.
Bottom Line for Investors
Weak economic data is likely to persist for months or maybe even quarters to come, as the pandemic continues to deliver headwinds on growth. But in my view, equity investors should be less focused on this nearer term economic data and more focused on where corporate earnings and the economy are likely to be a year from now, or even by the end of 2021. No one can know the answer for sure. But if I was asked if the economy and earnings are likely to be stronger and better than many people expect as of today, I’d say the answer is yes. Sometimes “better-than-expected” is all that matters.