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Are things good enough to deliver stock market gains in 2020?

Feb 21, 2020 | Frédérique Carrier


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The earnings season isn’t exactly setting the world on fire. But we sift through the clues that lead us to believe equities will see modest gains.

Q4 earnings wrap-up

The U.S. and Europe both have had a muted Q4 corporate earnings season. The former’s is mostly behind us with some 82 percent of S&P 500 companies having reported so far, compared to about half of the Euro STOXX 600, an index of eurozone companies, having released their numbers.

In both cases, the majority of companies have posted earnings beats. Seventy-one percent of S&P 500 companies and some 60 percent of Euro STOXX 600 companies that have reported so far exceeded consensus expectations. The beat ratio is a little lower than usual in the U.S., while it’s a bit higher than average in Europe. Both regions are generating earnings growth of three percent year-over-year. For the eurozone, this is the highest level achieved in the last five quarters.

In the U.S., the Utilities sector generated the strongest earnings growth, while Energy and Materials severely contracted. Technology and Health Care stood out with both a healthy surprise factor and earnings growth.

Earnings season in Japan, where 90 percent of TOPIX companies have reported, has been disappointing, with less than half overshooting earnings expectations. Moreover, earnings have declined by five percent year-over-year. Perhaps this shouldn’t come as a surprise given that Japanese GDP contracted by 1.6 percent in Q4.

Notably, Japan’s Consumer Discretionary sector has had a dismal showing as 60 percent of companies disappointed and earnings contracted by a whopping 21 percent. In our view, this poor performance may stem from consumers bringing forward purchases into Q3 before the imposition of a sales tax hike in October took effect. Typhoon Hagibis, which swept across the country in October and packed a devastating punch, may have compounded the sector’s pain.

We would expect the impact of these one-off effects to wane in time, and for earnings overall to improve in tandem with the global economic growth backdrop. If the yen weakens, the earnings environment of this exporting country would also likely benefit.

Muted U.S. and eurozone, disappointing Japan results
  S&P 500 Euro STOXX 600 TOPIX
Sales growth (y/y) 5% 4% -4%
Companies beating sales estimates 65% 59% 35%
Magnitude of sales surprise 1% 0% -7%

EPS growth (y/y) 3% 3% -5%
Companies beating EPS estimates 71% 60% 49%
Magnitude of EPS surprise 5% 5% -5%

Source - Refinitiv I/B/E/S, Bloomberg

Look at guidance for clues

More than past earnings themselves, management guidance is particularly important in gauging companies’ future prospects. RBC Capital Markets, LLC Head of U.S. Equity Strategy Lori Calvasina scrutinizes U.S. earnings announcements for common themes. This earnings season, she found that the majority of companies indicated the macroeconomic backdrop remains healthy, though the number that sees it as mixed or weak has increased steadily over the past three quarters.

Moreover, more than 40 percent of companies are emphasizing cost cutting. This proportion has grown steadily in the last five quarters, with the majority targeting general efficiency improvements, and a handful specifically mentioning either using technology to drive efficiencies or headcount reductions.

Lifting the veil on the coronavirus

The impact of the coronavirus is a key area of interest as it poses downside risk to 2020 earnings estimates if the virus is not contained soon. Companies can be impacted by a decline in their sales in China or through a disruption of their supply chains with parts or components becoming unavailable due to factory shutdowns.

At the time of the bulk of the U.S. Q4 earnings reporting, most management teams said it was simply too early to gauge the disease’s future impact on their businesses. As such, there is much more uncertainty in the air regarding the coronavirus than what we’ve seen with other past issues, such as the U.S.-China trade conflict, where estimates were easier to assess and guidance more readily offered.

More recently, a few companies have captured some of the impact in their guidance. Apple warned it would likely miss its Q2 revenue guidance due to potential supply chain disruptions, while weaker demand from China was weighing on Q2 sales. It declined to give specific numbers altogether.

As the European earnings season typically lags the U.S. by two to three weeks, corporate guidance there may offer a clue as to U.S. exposure to the outbreak.

A relatively low proportion of companies in Europe have issued guidance. Those that have are generally positive about the prospects for 2020, but they are also sounding increasingly guarded about the impact of the coronavirus. The companies that have mentioned it the most operate in the Industrials, Consumer Staples, and Consumer Discretionary sectors. But few have been brave enough to quantify the impact.

Spirits company Pernod Ricard lowered its earnings growth range to two percent to four percent (from five percent to six percent), while its competitor Remy Cointreau withdrew its guidance due to the uncertainties, as has luxury brand apparel manufacturer Burberry. Michelin cut its operating income target by close to 20 percent; however, this is probably an extreme case as the Chinese motor authority recently estimated the coronavirus could reduce 2020 car sales in China by up to 10 percent in a worst-case scenario.

The full-year 2020 consensus earnings estimate for the S&P 500 has been trimmed to $176 per share from $178 as of early December 2019. The one percent reduction is in line with what we usually see at this time of year as prospects become clearer, suggesting any impact from the coronavirus has not yet been taken into account.

The way forward

While earnings releases have not been scintillating, they have been “good enough” in the U.S. and Europe, while in Japan, investors will likely look past the one-offs that hit companies in Q4, i.e., the sales tax hike and typhoon. We continue to expect that earnings growth will be sufficient to underpin modest equity gains this year, though coronavirus-led volatility may well come back to the fore. We stress the importance of vigilance, but any such volatility could also provide investors with better entry points in China-exposed stocks at some point.

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