Stocks have soared in the past few weeks, coming back from a Coronavirus-induced bear market as investors have added back some risk to their portfolios. But the market’s bounce now understates the hit to earnings we are likely to see for more than a year out from this point.
Stocks moved higher Thursday despite jobless claims in the past week hitting 6.6 million, economists saying unemployment will be in the mid-teens in percentage terms, and Starbucks (SBUX) now expecting 32 cents rather than 34 in earnings per share for the quarter.
The Federal Reserve said it will extend $2.3 trillion in lending to small businesses and households, done through the central banks’ special purpose vehicles, or funds. That’s added on to hundreds of billions previously lent and $350 billion appropriated by Congress. And market participants also expect trillions more to be allowed for by Congress, which would include more money for small businesses, which are rapidly going under water.
Investors expect the stimulus to keep employment, small businesses and households afloat, while the virus potentially abates. Peak cases are expected in New York the week. The EU is seeing a slowing spread curve this week. The market, as a whole, thinks the liquidity is making the U.S. economy — likely in recession — primed for a sharp economic rebound later in 2020.
The S&P 500 had fallen 34% from its all-time-high hit in mid-February. It then rebounded 17.5% before settling for about a week. Strategists had pointed out that short-term traders added stocks at their bottom in early March and took profits after the 17% run. Pension funds rebalanced and added back some to their equity market positions.
Now, investors buying stocks are truly optimistic. The S&P 500 is up 25% from its 2020 low, out of bear market territory. And it’s only 17% below its all-time-high.
But here are the essential facts now.
Year-to-date, the index is down 14%. Earnings per share estimates on the S&P 500 index are coming down, according to strategists. UBS is looking for a 26% decline for 2020, which would leave the number at $121, a 32% drop from analyst estimates coming into the year. Morgan Stanley and Stifel are looking for the number to come in at $130. Goldman Sachs strategists say the number should be $110.
According to an aggregate forecast of equity analysts, EPS will be $156, just 12% under the $178 The Street was looking for at the beginning of 2020. And many observers have been quick to note the company specific analysts are lagging the reality, as they tirelessly sharpen their pencils and update their models.
For 2021, average EPS estimates are for $186, but Goldman Sachs says that should be closer to $170.
Banks may see 2022 earnings fall from prior estimates as well, according to a note from Goldman Sachs. Stock analyst Richard Ramsden, who covers JPMorgan (JPM) ., Wells Fargo (WFC) and other large cap banks, says earnings could fall 40% for 2020, as credit losses far overshadow higher loan volumes spurred by low rates and Federal Reserve lending programs for small businesses and households. And earnings could fall 16% and 10%, in 2021 and 2022 respectively in his view.
The virus may begin to abate, but a V-shaped economic recovery -- a sharp one -- may not be in the cards as the fallout of closed retail stores, unemployment, and potential household bankruptcies may be too great for the economy to snap back. Some are now looking for a U-shaped recovery, or a more gradual one, which certainly shows up in the 2021 earnings numbers.
As revenues fall by 15% for many companies, and more than 20% for others, earnings fall even harder. That’s because margins are contracting on the S&P 500 -- to the tune of 30 basis points according to Yardeni Research -- as companies pay fixed costs they can’t get out of.
Meanwhile, heavier and riskier debt burdens are sure to be an additional source of valuation compression.
The point: either the U.S. market needs to stay put for almost a year or retest the lows it exhibited in early March in order to price stocks according to their fundamentals.