Deep Earnings Recession
Before the coronavirus hit the mainstream corporates were already in an earnings recession. In a piece entitled, “Earnings Recession” dated November 2019, I wrote, “the overall three straight quarters of year-over-year earnings declines suggest that companies are deep into an earnings recession.” I noted that the latest Q3 earnings 2019 had clocked that number to 3 consecutive quarters of year-over-year declines.
A deep earnings recession is now on the cards, bearing in mind that the coronavirus-induced collapse in profits has accelerated an existing trend of declining corporate profits
But with the second-quarter earnings season just a few weeks away investors/traders are no doubt wondering about just how bad will this deep earnings recession be.
So several analysts have thrown their hat in the ring with their deep earnings recession forecast.
Moreover, it is Goldman Sachs (GS) who is leading the gloomy mood with its deep earnings recession forecast.
“Earnings will fall by 60% in the quarter”, according to the investment bank. If so the collapse in second-quarter earnings underscores a deep earnings recession, which is expected to be the worst print since the financial crisis.
The S&P 500 EPS was negative 15% in 1Q 20. The consensus for earnings is negative 44% in 2Q 20 with GS being more bearish expecting a negative 60%.
Then in the final half of 2020 consensus narrows. S&P 500 EPS is expected to also be negative 24%, with GS forecasting negative 30%.
But in 4Q 20 S&P 500 EPS consensus is for a negative 14% with GS forecasting negative17%.
Given the recent resurgence in the coronavirus cases around the globe, the coronavirus-induced collapse is likely to continue in 2020, thereby making an earning-recession inevitable
In Europe, some regions have been ordered back into lockdown.
For example, the UK’s first full local lockdown was announced in Leicester, with stricter measures imposed in the city. There has been “10% of all positive cases in the country over the past week”
said UK health secretary Matt Hancock.
Furthermore, three districts in the Aragon Spain area are back in lockdown to deal with rising coronavirus infection rates.
In India, the fourth worst hit country in the world behind only the United States, Brazil, and Russia, according to Johns Hopkins University data, the number of cases has spiked to now over 332,000.
Also reported in June China, Beijing has put into partial lockdown.
In the US the coronavirus crisis deepens.
“New infections in the US climb to more than 68,000, the seventh record in 11 days,” according to The New York Times.
The coronavirus-induced collapse in profits is not over, making a deep earning-recession inevitable, which could also morph into another great depression
Energy and Consumer Discretionary are expected to lead the deep earnings recession due to a sharp decline in oil prices and the direct impact of coronavirus shutdowns
Financials companies are also expected to be weak as Banks build additional capital reserves to cope with an anticipated surge in bankruptcies and nonperforming loans. Goldman’s Banks team expects earnings to decline by 69%
Technology companies are expected to fear best in the coming deep earnings recession
Analysts expect Info-Tech EPS to decline by just 9%. Companies in the defensive consumer non discretionary space, such as utilities are the only sector expected to grow with an EPS in 2Q (+2%) in 2020.
Recession-proof sectors include food, water, pharmaceuticals, and basic healthcare. Companies in these sectors also have cash flow that identifies as a store of value.
Surprisingly the deep earnings recession in 2020 is not driven by a lack of sales, but rather a decline in margins
“More of the 2020 decline in earnings is driven by margin contraction than by a drop in sales,” according to GS.
Many companies have adjusted their revenue models online or curbside but are experiencing extra costs associated with reopening safely.
Excluding Financials and Utilities, Goldman forecasts S&P 500 sales growth of -8% in 2020, +13% in 2021, and +7% in 2022, and net profit margins of 8.6% (-205 bp) in 2020, 11.1% (+250 bp) in 2021, and 11.5% (+40 bp) in 2022.
When is the deep earnings recession likely to turn around?
The consensus is that a rebound in earnings will play out in 2022, but that is following a 24% decline in 2020.
The consensus now expects 2021 EPS of $162 (+30%) and 2022 EPS of $187 (+15%), both below Goldman’s top-down estimates.
Would a vaccine reduce the impact of deep earnings in recession in the short term?
Already large scale bankruptcies have been noted in the past few weeks alone.
So if a vaccine were approved and distributed speedily, it would generate only a moderate swing to the bank’s bullish baseline 2021 EPS estimate.
The presidential elections are another wild card adding to the uncertainties of an already deep earnings recession
The odds of a Democratic win in the 2020 elections has increased substantially since February and now stands above 50%.
The Democratic candidate Biden has outlined a $700 bn economic fiscal stimulus plan. The large fiscal expansion would likely provide a tailwind to economic growth and S&P 500 EPS. But with that would come Biden tax reforms, which could reduce S&P 500 earnings estimate for 2021 by $20 per share, from $170 to $150, according to GS.
So we could be seeing fiscal and monetary policy working in tandem, known as MP3 State Capitalism, which puts the government at the epicenter of capital distribution to lessen the impact of a deep earning recession. So the theory goes but will it work?