Summary
Earnings are expected to be down 12.7% in the most recent quarter, with 275 of the S&P 500 companies now reporting. Consensus earnings for 2Q2020 are down 37.8%.
1Q2020 GDP in both the U.S. (-4.8%) and Eurozone (-3.8%) was worse than expected, and the consensus outlook for the 2Q is dire for both regions, very similar to the outlook for most countries around the world
The S&P 500 had its best month in April since 1987, with a gain of 12.7%. Other major equity markets also were firmly in the green, although none performed as strongly as the U.S. equity markets. However, the momentum built up during April began to wane in the latter half of last week, with a truly dismal start to the month of May on Friday.
Credit spreads continued to tighten across the board (almost), especially notable in the B-rated segment of the market. The one exception is the CCC-rated segment, which remains under severe pressure with spreads near 18%.
COVID-19 cases are continuing to slow. Some European countries have target dates and plans for the first phase of re-opening, but the U.K. does not have definitive plans yet. The U.S. government is largely leaving the decision to the states, and some are already starting to re-open while others are taking a more cautious approach.
Earnings
The best source for recapping aggregate earnings for the S&P 500 remains Refinitiv, and you can find their recap for last week’s earnings here. By now, most of this will be old news, but three things stood out to me that are worth mentioning.
Now that 275 of the S&P 500 companies have reported, let me first emphasise how dire the earnings outlook remains for most companies in the coming quarters. Although 1Q2020 revenues are expected to be flat versus 1Q2019, consensus earnings are expected to be down 12.7% versus 1Q2019. Perhaps more troublesome is the 2Q2020 outlook, in which consensus earnings are projected to be down a whopping 37.8% versus 2Q2019. The trailing P/E ratio of the S&P 500 index on Friday was 20.3x, with the P/E ratio generally hovering in the 20-24 range since the beginning of 2015 (see multpl.com). Looking forward, the S&P 500 is currently trading at 21.6x forward (2Q2020 – 1Q2021) earnings. Below is a graph from Yardeni Research that depicts the forward P/E ratio of the S&P 500 over the last 15 years.
Earnings performance so far in 1Q2020 is largely in line with expectations as far as the 11 main S&P 500 sectors. Information technology (semiconductor, software, etc) and consumer staples (agricultural products, food retail, etc) are expected to be the best two performing sectors in 1Q2020 as far as earnings growth, and consumer discretionary (department stores, casinos & gambling, etc) is expected to be the weakest. Interestingly, looking forward to the 2Q2020, only the utilities sector is expected to have positive earnings growth.
The one specific disclosure that most caught my eye last week was the cost of CV19 that #AMZN is projecting for the 2Q2020, which was contained in the company’s 1Q2020 earnings release. Now to be fair, the on-line / logistics portion of Amazon’s business - one of its major growth engines (not to mention its heritage) - is a “hands-on, close proximity” business that has to adjust to the new world of social distancing, and this clearly has costs. Nonetheless, $4 billion – the entire operating profit expected in 2Q2020 – is a huge number, but more importantly provides a benchmark perhaps for many other companies that are not able to be “automated” and have to rely on humans working together. Amazon is up-front about it, but I can’t help but wonder how expensive this might be for many other companies that must adapt to the new state of the pandemic-infected word.
Economic News
Again, rather than rehash old news, let me mention only the four most salient things that I recall from last week.
1Q2020 GDP was announced for the U.S. and the Eurozone. The U.S. came in at negative 4.8%, and the Eurozone came in at negative 3.8%. According to the “GDP Now” from the Centre of Quantitative Research, consensus 2Q2020 GDP for the U.S. has been revised further down (May 1st) to -16.1%. The chart below shows how U.S. economic growth has been revised downward as the damage from COVID-19 has become more apparent over time.
Another 3.84 million Americans filed for unemployment last week, bringing the six week rolling total to 30.3 million Americans (of a labour force of 160 million). Employment data for April (unemployment rate and NFP) is released this coming Friday (May 8th), with consensus expectations hovering around 14%. There is also factory orders, production (PMI) and non-manufacturing data coming from the States this week – see MarketWatch.
The Federal Reserve released its FOMC statement on April 29th. The federal funds rate was left at the 0%-0.25% range, and the Federal Reserve committed to continue its accommodative use of monetary policies to ensure “smooth market functioning.” The following day, the Fed announced the expansion is scope of its Main Street Lending Programme to assist small businesses.
The European Central Bank (ECB) announced that it would leave over-night bank financing rates unchanged (-0.50%), left the QE programme in place with a caveat that it could increase the amount and/or scope if the pandemic worsened, and expanded the scope of collateral while lowering the cost of its collateralised lending programme for European member banks. LTRO collateral was already expanded on April 22nd to include “fallen angel” bonds. You can find the April 30thpress release from the ECB here.
Global Equity Markets
The S&P 500 ended April with one of its best months ever, up 12.7%. Other major exchanges followed suit, with solid gains in April although none were as strong as in the U.S. The S&P 500 had its best month since 1987 and its best April since 1938. However, May started with a bust on Friday, although the STOXX 600 was spared since Friday was a holiday in most of continental Europe and the markets were closed.
I suppose the jury is still out on whether April was a new beginning or a bear market bounce. Warren Buffet’s opening comments at his annual shareholder meeting Saturday afternoon did catch my ear because I did not realise that it took the DJIA 25 years (until 1954) to reach its pre-depression high of 381.17 on Sept 3, 1929. After reaching its high in 1929, the Dow Jones fell nearly 90% to reach a low less than four years later in July 1932 of 41.22. Sure, times have changed in so many ways that it might make this largely irrelevant, but every now and then, equity investors need to keep in mind how easy it has been to make money since at least the mid-1980s. Sticking with the DJIA, here’s how the trajectory has looked.
Had you invested $1 in the DJIA in 1985, it would be worth $18.58 today, a CAGR of around 9%/annum over the period.
Credit markets
Through Thursday (last data), credit spreads continued to grind tighter in the BBB, BB and B ratings categories, with the most pronounced tightening being in the B category. CCC-rated credits bucked the trend though, with spreads widening in the most troubled tier of the high yield market by 80bps on the week. The table below illustrates that spreads have tightened across the board in the U.S. and European high yield markets since the March 23rd highs.
COVID-19 Data will begin to trickle in over the coming weeks on just how economies that are reopening will fare during the post-lockdown period. There are U.S. federal guidelines, but the U.S. government has left the specifics to states, some of which are already starting to emerge from lockdown. The U.K. has not announced any definitive date for reopening its economy, whilst several European countries – including Switzerland and France – are starting their first phase of re-emergence on May 11th.
Below is the table updating the trajectory of COVID-19 cases and deaths since I started tracking these, and below the table is the updated map from Johns Hopkins which you can also find here. The table below shows that the number of cases began to slow starting in late April, and the hope of course is that this carries on.
Conclusion
This is likely to be a pivotal week as far as market direction in which we should find out if there is broad enough strength to maintain the April rally. If so, it will be in the face of (at best) mixed corporate earnings new and an increasingly dire economic outlook. However, there is plenty of liquidity to pump up asset prices, and investors have a way – generally correctly – of looking several quarters out. Investors in the U.S. may also be spurred on by Mr Buffet’s assertion on Saturday – “never bet against America.”