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Will Rising Infections Derail Improving Earnings?

Sheraz Mian
·7 min read

Note: The following is an excerpt from this week’s Earnings Trends report. You can access the full report that contains detailed historical actual and estimates for the current and following periods, please click here>>>

Here are the key points:

  • The third quarter results reconfirm the steadily improving earnings outlook that we have been highlighting since early July. We are seeing an above average proportion of companies beating Q3 estimates and expectations for the current period (2020 Q4) are going up.
     

  • The market has been less than enthusiastic about positive Q3 earnings results, as it appears preoccupied with handicapping the impact of the ongoing surge in infections on the economy and corporate earnings.
     

  • For the 206 S&P 500 members that have reported Q3 results already, total earnings are down -11.3% from the same period last year on -3.5% lower revenues, with 83.5% beating EPS estimates and 78.2% beating revenue estimates.
     

  • This is a notably better performance than what we saw from the same group of 206 companies in the first half of the year, with the EPS and revenue beats percentages tracking significantly higher than other comparable periods.
     

  • For the Technology sector, we now have Q3 results from 35.4% of the sector’s market capitalization in the index. Total earnings for these Tech companies are up +4% from the same period last year on +1.4% higher revenues, with 92.9% beating EPS estimates and 85.7% beating revenue estimates.
     

  • For the Finance sector, we now have Q3 results from 56.1% of the sector’s market capitalization in the S&P 500 index. Total earnings for these Finance companies are down -7.8% on +1.4% higher revenues, with 69.4% beating EPS estimates and 77.6% beating revenue estimates.
     

  • Looking at the quarter as a whole, total S&P 500 earnings are expected to decline -15.2% on -2.0% lower revenues. The growth picture has been steadily improving since early July, but the pace of improvement has started accelerating as companies have come out with better-than-expected results.
     

  • Sectors with the weakest Q3 growth outlook remain the social-distancing exposed spaces like Transportation (-117.1% earnings decline), Energy (-113.0%), and Consumer Discretionary (-84.3%).
     

  • Out of the total 16 Zacks sectors, 13 sectors are expected to experience earnings declines in Q3, with Construction, Medical and Technology as the only sectors expected to show earnings growth.
     

  • Utilities (-1.4%) and Retail (-3.1%) are the sectors with the lowest expected earnings declines in Q3. The Finance sector’s current decline of -7.5% represents an improvement from the -23.1% decline expected before the banks started reporting results last week.
     

  • For the current period (2020 Q4), total S&P 500 earnings are expected to be down -11.9% on -0.3% lower revenues. Estimates for the quarter are steadily going up, a trend that we saw in Q3 as well.
     

  • For full-year 2020, total earnings for the S&P 500 index are currently expected to be down -19.1% on -4.4% lower revenues. As with Q3 estimates, full-year estimates have improved since early July.
     

  • Growth is expected to resume next year, thanks to easy comparisons, but the dollar level of earnings in 2021 will still be below the 2019 level.
     

  • The implied ‘EPS’ for the S&P 500 index, calculated using current 2020 P/E of 26.2X and index close, as of October 27th, is $129.40, down from $159.94 in 2019. Using the same methodology, the index ‘EPS’ works out to $159.75 for 2021 (P/E of 21.2X). The multiples for 2020 and 2021 have been calculated using the index’s total market cap and aggregate bottom-up earnings for each year.
     

  • Please note that while full-year 2021 earnings for the S&P 500 index are currently expected to be up +19.1% from the 2020 level, the absolute dollar amount of 2021 earnings estimates remain below the 2019 level.
     

  • For the small-cap S&P 600 index, Q3 earnings are expected to be down -25.9% from the same period last year on -6.9% lower revenues, which would follow a -65.3% decline on -17.5% lower revenues in 2020 Q2.
     

  • For full-year 2020, the S&P 600 index is expected to experience a -38.4% decline in earnings on -7.3% lower revenues, with easy comps pushing earnings growth to +41.2% in 2021.

 

 

The earnings outlook has been steadily improving since early July, as the U.S. economy started coming out of the pandemic-driven slump. While pockets of entrenched weakness remain, the pace and magnitude of the recovery has largely been better than expected.

This improving trend has been showing up in positive estimate revisions, with analysts steadily raising their estimates. We saw this earlier with Q3 estimates and we are starting to see the same trend in play for Q4 estimates as well, as the chart below shows.

 

 

 

 

 

 

 

 

 

 

 

It is reasonable to expect this trend of improving earnings estimates to continue as we go through the rest of the Q3 reporting cycle. The worry is that the improving trend will level off or even reverse in the face of surging infection rates that weighs down the economy’s recovery. We are starting to see this unfavorable trend play out in Europe at present and the worry is that the U.S. economy may be a few weeks behind Europe.

These Covid worries and associated macro uncertainties appear to be making market participants discount better than expected Q3 results, with an above average proportion of companies beating EPS and revenue estimates. That said, companies missing estimates or providing weak guidance are getting the appropriate level of punishment, as we saw with Netflix (NFLX), Intel (INTC), J.B. Hunt (JBHT) and others.

Looking at Q3 as a whole, combining the results that have come out with estimates for the still-to-come companies, total S&P 500 earnings are expected to decline -15.2% from the year-earlier level on -2.0% lower revenues.

The chart below shows the quarterly earnings and revenue growth picture.

 

 

 

 

 

 

 

 

 

 

 

 

Looking at the outlook on an annual basis, index earnings are expected to decline -19.1% this year, after staying essentially flat last year. Growth is expected to resume next year, with easy comparisons driving most of the growth. The chart below shows the overall earnings picture on an annual basis.

 

 

 

 

 

 

 

 

 

 

 

 

The recent flow of economic readings has been broadly positive, suggesting that the hoped-for recovery is firmly in place. Consensus estimates suggest a very strong GDP rebound in Q3, which would follow the -31.7% decline in Q2. Estimates for Q4 have a wide range, reflecting uncertainty about the pandemic and relief spending.

The hope is that the recovery in the economy, as well as the earnings outlook doesn’t lose pace in the face of rising infections and delayed fiscal relief.

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