With Earnings On The Horizon, How Low Are Expectations?

By: Spencer Israel

Time flies when there’s volatility in the market—the Q2 earnings season is already around the corner. Unlike the Q1 earnings season, which included two months of pre-coronavirus activity, these reports will reflect April-June for most companies, which means we’ll get a more complete look at how the statewide shutdowns impacted business.

The heavy earnings flow will start the week of July 13. JP Morgan, Wells Fargo, Citigroup, Goldman Sachs, Bank of America, Netflix, Johnson & Johnson, IBM, PepsiCo and Dominos are just a few of the companies reporting that week. 

Expectations Are Historically Low
According to Refinitiv, the estimated earnings growth rate for the S&P 500 for the second quarter is -42.7%. Companies have spent the better part of the last four months setting the bar extremely low for themselves, though expectations have been raised somewhat in recent weeks as states began to reopen.

Only 49 S&P 500 companies even issued EPS guidance for Q2, according to FactSet. That marks a record low since they began keeping track in 2006. However, the percent of upward earnings revisions for S&P 500 companies have actually outnumbered the percent of downward revisions in June, a sign that expectations aren’t quite as low as they were in April and May. 

Source:  I/B/E/S data from Refinitiv

Source:  I/B/E/S data from Refinitiv

In terms of specific sectors, the bar is lowest for the energy and consumer discretionary sectors. From the end of 2019 through the end of May, earnings for companies in those sectors fell 105% and 58% respectively. 

Unsurprisingly, the defensive utilities sector and work-from-home-enabling information technology sector are expected to hold up the strongest. EPS estimates for those sectors have only slightly declined in 2020.

Source: FactSet

And yet, the performance of those sectors reflects the stark contrast in how equity investors are choosing to ride out the storm. 

Year-to-date, the Utilities Select Sector SPDR ETF (XLU) was down 13% as of June 26, while the Information Technology Select Sector SPDR ETF (XLK) was up 13%. On the weak end of the earnings spectrum, the Energy Select Sector SPDR ETF (XLE) was down 37% year-to-date, while the Consumer Discretionary Select Sector SPDR ETF (XLY) was up 1%. 

The takeaway is that, though important, earnings growth is not always the dictator of performance. The numbers companies report in the next few weeks will likely be far worse than what we got last quarter, and we will likely get very little clarity in terms of forward-looking guidance.  

The good news is the earnings bar is historically low in the minds of investors. The bad news is it still may be too high for some companies. 

The author is long the S&P 500 in his retirement accounts.

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