US earnings season a new test for coronavirus-hit Wall Street

After US stocks’ recent rally, analysts worry earnings season could spark another sell-off, as more COVID-19 damage emerges.

Could Wall Street be in for another reckoning? The New York Stock Exchange in New York. Picture: AP

The kick-off of US earnings season this week will give investors a first glimpse of the impact of the coronavirus shutdown on corporate profits -- and potentially clues about the outlook for the rest of the year.

Those results will offer a test for a stock market that is attempting to rebound after a bruising sell-off. The pandemic is expected to cause a severe economic contraction and a sharp decline in corporate earnings in 2020. What remains unknown is the extent of the damage.

Companies from General Electric. to FedEx and Starbucks have warned they can no longer forecast their own results in a period of such uncertainty. Businesses across the country say revenue has evaporated following stay-at-home orders and the closure of non-essential businesses, leading them to furlough employees and drastically cut spending as they try to stay afloat.

Despite the turmoil, stocks have rallied over the past three weeks on early indications that social-distancing practices are helping to slow the spread of the virus. The S&P 500 climbed 12 per cent last week, its best weekly performance since 1974, and it has rallied 25 per cent from its March 23 low. The index is still down 14 per cent for the year.

“It’s been remarkable to watch markets just climb higher and higher,” said Emily Roland, co-chief investment strategist at John Hancock Investment Management. “We haven’t really seen markets reflect the full extent of the damage that coronavirus is having to corporate profitability.”

For that reason, some analysts worry the stock market is on the cusp of a reckoning and another painful sell-off could be in store if corporate profits plunge. Others fear Wall Street’s current earnings estimates don’t fully reflect the extent of the expected carnage. Because projections for earnings are a key part of how stocks are valued, the opaque view into corporate profits suggests major indexes could see more volatility ahead.

Big banks including JPMorgan Chase & Co and Bank of America,, along with health-insurance giant UnitedHealth Group, transportation bellwether JB Hunt Transport Services and health-products company Johnson & Johnson, will be among the first big companies to open their books this week. While those results will be of great interest, investors will more carefully scrutinise comments from executives for indications of what will come later this year.

“There is more uncertainty for this quarter than almost any quarter I can remember,” said Bob Doll, chief equity strategist and senior portfolio manager at Nuveen. “My guess is somewhere between a half and three-quarters of analysts have yet to take a knife to their earnings (estimates) because they don’t know what knife to take to them and how deep to cut.”

The range of estimates reflects the deep uncertainty about the path ahead. FactSet projects a 9 per cent year-over-year decline in earnings for all of 2020, based on analysts’ expectations for individual companies in the S&P 500, a sharp reversal from the 9.2 per cent growth anticipated as last year ended.

Such a decline pales in comparison with the profit collapse forecast by big banks. BofA Global Research projects a 29 per cent drop in per-share earnings this year, an estimate that incorporates “cataclysmic losses in travel, restaurants and other industries directly impacted by social distancing.” Goldman Sachs has predicted profits will tumble 33 per cent, while cautioning that in a more painful slowdown, the decline could be 57 per cent.

The second quarter is expected to see the brunt of the damage based on the current scale of the shutdown. Profits among companies in the S&P 500 are projected to drop 21 per cent in the current quarter after sinking 11 per cent in the first three months of the year, according to FactSet estimates. In the second half of the year, profits are expected to continue shrinking, but at a slower pace, falling 9.6 per cent in the third quarter and 1.6 per cent in the fourth.

“We’ve never, ever, ever seen a sudden stop of the economy,” said Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management. “That’s why this is going to be such a scrutinised petri dish, if you will, of an experiment for people to understand, really, what are the companies that have a true resilient and recurring revenue stream?”

First-quarter earnings forecasts have dropped for all 11 sectors in the S&P 500. The pain is projected to be particularly acute among companies in the consumer-discretionary group -- a category that includes hotels, cruise lines and restaurants -- where profits are expected to sink 32 per cent from a year earlier, according to FactSet.

Marriott International, for one, has begun furloughing what it expects will be tens of thousands of employees, while temporarily closing properties and curbing other spending. Shares of the company, which has withdrawn its financial guidance, are down 46 per cent this year.

Meanwhile, earnings among energy companies, which have been hit both by an unprecedented drop in demand and the price war between Saudi Arabia and Russia, are expected to plummet 52 per cent. Both Exxon Mobil Corp and Chevron Corp have slashed their capital spending plans in response to the crash in oil prices. Those stocks are off more than 30 per cent in 2020.

One of the brighter spots is expected to be the communication-services sector, which includes Facebook and Google parent Alphabet. Earnings among those companies are projected to grow 7.8 per cent, down from an expected 17 per cent growth at the end of last year. Analysts are calling for profits at Facebook to more than double, despite a slowdown in advertising due to the pandemic. Its shares are down 15 per cent this year, in line with the broader market.

“We’re looking forward to earnings season with a particular fascination to see what we learn about different companies’ business models,” Morgan Stanley’s Ms. Shalett said. “We’re also going to be put in a place where we have to all think really hard about to what extent is both consumer and business behaviour changing, semi-permanently or permanently because of this trauma and this sudden stop in the economy.”

Wall Street Journal