Earnings season: the story so far

The latest earnings season for US stocks is only just getting into its stride, but already we can draw a few themes from the reports released so far.

Firstly, the quarter just gone is only having a limited impact. The shutdowns in the US only really gained traction in late March, covering only the final weeks of the quarter. While there was some weakness in performance in some sectors before this, it was relatively limited. The real effect will be seen in the second quarter (Q2), when shutdowns are in full swing.

Q1 earnings forecasts

Estimates for the Q1 earnings season have been furiously revised down in the past few weeks, from a 4% gain in January to a 5% decline overall as of the end of March. However, forecasts have been cut as the season has got underway, and double-digit percentage declines are now expected, with a drop in earnings of 14% now expected. Even these lowered forecasts may be tough to beat, given that so many companies have withdrawn guidance for the next quarter and beyond.

Usually, low earnings forecasts can prove to be a positive thing. Forecasts that have been guided down ahead of earnings are easier to beat, and can thus provide a positive surprise for individual stocks and for the index overall. But we are living in unprecedented times. Widespread shutdowns around the globe have essentially put the global economy into a deep freeze at best, and risk a long recession or even a depression at worst.

While we have signs that the lockdowns are being eased in some places, providing a template for other economies to follow, there is no guarantee that they will not be reimposed if infection rates begin to rise once again.

Shift in investors’ approach

Faced with this unprecedented situation, investors have completely changed how they look at earnings season. Before, it was about picking those with good growth and promising outlooks for the near term. Now they have turned to focus on those companies that will survive this crisis, or least look in good shape to survive it. Now, cash and good borrowing will be key, as companies focus not on growing sales over the next three months, but on maintaining their cash piles and keeping their businesses ticking over for as long as possible.

Of course, from looking at the stock market you could be forgiven for thinking that the worst is over. Indices have rallied sharply from their March lows, and while the gains have slowed, they have yet to make the kind of sharp turn lower that would suggest a new slump is on the cards. Given how earnings forecasts have been cut, it seems odd to see equities in the US trading at levels seen only six months ago, when the outlook was much brighter.

The reality is that things could still get much worse, or at least not improve very much. But with so much of the bad news ‘in the price’ now for both corporate and economic data, it will take a major revision of the economic landscape, either for better or for worse, to really have an impact on stock prices.

Investors know this earnings season will be bad. However, the full extent of the damage will only become clear later in the year. Then equities may be at risk of further sharp falls.

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