Blithe Bulls Find Just Enough to Like in Decade’s Worst Earnings

The bad news, if anyone needs the reminder, is that U.S. companies are currently in the process of reporting the worst quarterly profit decline in 12 years. The good news is that despite a lot of day-to-day volatility, nobody in the stock market seems to care.

Three weeks after companies began reporting, the S&P 500 is en route to an earnings-season advance that will rank among the best of the last five years. Income is poised to fall 35% at a time when valuations are inflating — and stocks just capped their best July since 2010.

One explanation is that certain earnings-season trends have not been as bad as Wall Street expected. More than 80% of companies are beating analyst estimates — potentially a record. Forward guidance has been scant, but the little that companies have ventured has been positive. The slope of earnings revisions by analysts is tracking at their best level since January. Price-earnings ratios are high, but next to bloated valuations in bonds, they don’t look so bad.

Beyond that is Federal Reserve support and just the dauntless optimism that has proved impossible to shake among equity investors, many of them newly minted day traders enticed by commissionless brokerage accounts. After a late Friday surge, the S&P 500 rose for a fourth week in five, closing out July with a 5.5% gain.

“Investors are really kind of looking through the earnings season because we know that it’s going to be poor,” Victoria Fernandez, chief market strategist for Crossmark Global Investments, said in an interview on Bloomberg Television. “The market is responding not just to what’s happening now. It’s responding to where it thinks we’re going to be two quarters from now.”

Also, though it’s the sort of optical illusion that people decry, at least when it comes to corporate earnings, things are virtually assured to get better. Analysts expectprofits for S&P 500 companies to improve for the rest of this year before staging a 25% rebound in 2021 to $161.50 a share, data compiled by Bloomberg Intelligence show. Based on that estimate, the index was valued at 20 times forecast earnings. While not cheap, it’s not outrageous, either, with bond yields hovering near record lows.

The S&P 500 added 1.7% over five days while the Dow Jones Industrial Average fell 0.2%, dragged lower by energy and industrial companies. Thanks to blowout results from Apple Inc. and Amazon.com Inc., the Nasdaq 100 performed better, climbing 4% to end its first back-to-back weekly loss since March.

The S&P 500 has advanced 3.3% since this reporting season began as 64% of the firms that announced results exceeded sales forecasts. That’s higher than the 10-year average of roughly 50%.

Management commentary has shown improving sentiment. Mentions of “optimistic” or “optimism” on conference calls held by S&P 500 companies are on course for the highest level since at least 2003, according to data compiled by Bank of America.

“Almost every single one of these companies has told us they have seen improving trends and we have seen some of the high frequency data suggest improving trends,” said Yousef Abbasi, global market strategist at StoneX. “I do think that Q2 will be the trough of earnings.”

That’s the spirit underpinning a four-month rally in which the S&P 500 is up about 40% and more than $10 trillion has been added to equity values. Beneath it, of course, is caution over the pandemic, with investors continuing to favor the stay-at-home trade, in particular tech megacaps, whose products facilitate social distancing.

These bets paid off when results from Amazon, Facebook Inc. and Apple blew past estimates and their stocks each jumped an average 7% the next day. It’s a boon toRobinhood traders, who have raised their bets on the group, standing firm despite mounting valuation angst heading into earnings.

The refrain from going all in was also evident in the retreat from cyclical shares like commodity producers. While the worst losses in a generation fromExxon Mobil Corp. and Chevron Corp. didn’t help, investors turned leery ahead of a week that could see weak payrolls, and a month that’s historically themost volatile on record.

“A lot of companies are struggling, there’s not a lot of visibility,” said Alec Young, chief investment officer at Tactical Alpha LLC. “You really need better visibility on a vaccine or how the virus peaks out and know we’re through the worst of this.”

At least on the earnings front, the wost scenario didn’t pan out. At the end of June, second-quarter profits were forecast to plunge 44%. Now, the expected contraction has narrowed to 35%.

Expectations for the current year have been improving. Analysts now expect 2020 earnings to drop 20.7%, about a percentage point less than the decline expected a week ago and the smallest projected drop since early May. The increase over the last week for 2020 EPS estimates is the largest upward revision for the year on record in Bloomberg data, hinting that negative revisions are a thing of the past.

Indeed, after rushing to slash forecasts at the early stage of the pandemic, analysts are now turning more upbeat. Upward earnings revisions have outpaced downward revisions for the first time since January, data compiled by Jefferies showed.

“The markets were once again ahead of game,” said Brad McMillan, chief investment officer for Commonwealth Financial Network. “That kind of confirmation can only help push things further up.”

Source: Read Full Article