Equities special: Earnings car crash, what are companies’ telling us?

The start of earnings season is upon us. The US has kicked things off for the first quarter of 2020, and so far, the markets have not been impressed. While some companies managed to weather the storm for Q1 and produce decent enough profits, it was the outlooks that have spooked investors and helped to put the brakes on the financial market recovery that started on around the 23rdMarch and may have ended last week. 

There are plenty of factors that are driving stock market direction right now, but it is worth taking a deep dive into earnings season and looking at how this could impact market performance in the short to medium term. Below we look at the key outcomes from earnings season so far, what to expect in the coming days and also what it means for the overall performance of risky assets. 

1, Earnings so far 

Key earnings releases include JP Morgan, Wells Fargo, Goldman Sachs, Bank of America and Citigroup. The US banks are at risk from the Covid-19 economic meltdown on two fronts: firstly, ultra-low interest rates limit what they can earn from their lending businesses; and secondly, a deep recession is now expected this year, which could increase the rate of bad loans. On top of that, fee-based income from M&A activity has dried up since March, as global deal making has ground to a halt.  

JP Morgan delivered some sour news on Tuesday, not only did Q1 profits plunge 69% to the lowest level in 6 years, but the bank also said that it was boosting its loan loss provisions by nearly $7bn (the amounts of cash it needs to cover bad loans) by the largest amount for a decade. This is bad news: a dramatic increase in loan loss provisions means that the world’s largest banks are expecting the global economy to face a long period of economic recession. Goldman Sachs, which has a larger trading business than some of its rivals, posted a profit of $3.11 a share, which was better than analysts had expected, however its share price plunged by more than 1.5% in pre-market trading on Wednesday, as its CEO said that results were negatively impacted by Covid-19. This should worry traders as GS is one of only a few global banks that are shielded from the Covid crisis because of its reliance on trading revenue, which has done well on the back of unprecedented volatility across financial markets. However, if markets remain unimpressed by GS and its share price continues to fall on Wednesday, then this would be a clear signal that risk is out of fashion, and financial markets could be in for another decline.

Looking forward, banks will have a hard balancing act in the coming months between tightening underwriting standards (making it harder to get a loan) to ensure that they do their best to get their money back in a deep economic recession, and at the same time helping the economy to recover by lending to businesses. As Jamie Dimon, the boss of JP Morgan said, the global economy will not bounce back, instead it will be a prolonged recovery. He does not expect the US economy to be back functioning again until ‘June, July or August’, although he does think that the unprecedented Fed and government support should cushion some of the damage. Dimon may have been looking for a positive spin on things, the truth is that forecasts for banks’ future revenues is almost impossible at this juncture when we don’t know when global economies will return to normal. This is what is keeping a lid on the financial sector and overall risk sentiment on Wednesday. 

2, Prepping for future earnings releases  

Trying to analyse earnings data has become a lot harder since the pandemic. We have found it useful to divide the major global blue chips into two groups. The first group include those companies that are likely to take a large financial hit (in varying degrees) caused by Covid-19, the second group includes the most defensive companies and those that could do well throughout this crisis. While Q1 results won’t give us the full picture of the damage that Covid could do to the global economy, we will have to wait for Q2 results to find that out, they could give us a good steer. 

Group 1: 

Below, we take a look at group 1 sectors and companies in more detail: 

Energy stocks:we expect the energy sector to be badly hit. Firstly, because energy demand is likely to drop sharply because of the upcoming recession, and also because of the dramatic decline in oil prices caused by the Saudi/Russian spat that saw oil fall to its lowest level since 2012. Even though Opec agreed to production cuts earlier this week, this hasn’t supported the oil price. Brent crude is down some 5% on Wednesday and any recovery in the oil price looks tepid and an opportunity to sell it further. With no clear sign when or how the oil price will recover, we expect oil companies like Shell and BP to give very bleak assessments when they announce their results at the end of this month. We expect industrial and materials companies to also report weak earnings. 

Airlines:it’s a given that global airlines will be decimated by the Covid-19 crisis. Most of them are struggling to survive, with some relying on government bailouts. It is also anyone’s guess when the global travel industry will emerge from lockdown, we believe that travel restrictions will be one of the last things to be lifted once the Covid threat is contained. Thus, we expect airlines’ share prices to struggle, although there may be some differentiation among companies. For example, IAG could outperform some of the short haul carriers like Ryanair and EasyJet going forward. Also, IAG could benefit if Virgin is allowed to fail by the British government. There are a lot of what ifs, and due to this we would keep away from airlines for now, or only trade airline stocks on very short time horizons. 

Banks:see above, some banks will outperform, but overall a once in a generation economic downturn is bad news for the banks. 

Insurers:This is one sector that we will be looking at closely. While the enforced shutdown of the global economy, in theory, should lead to a large number of claims, how many of these claims will insurers pay out? While we expect insurers to push a hard bargain when it comes to paying out for Covid-claims, playing hard ball could also impact the long-term outlook for insurers. Either they have to pay out record amounts in claims, or they risk their reputations and a potential backlash and future regulation, by refusing to pay out. Banks and insurers have a difficult path ahead – save their cash reserves, or save the global economy? 

Tech:this is a difficult sector to analyse as there will be some big winners, such as Amazon, however, what about Google and Facebook? While demand for social media has grown substantially since the crisis began, what about advertising revenue, the lifeblood of some of the tech titans? We expect ad revenue to plunge in the coming months, which could hurt some of the tech titans, however, one caveat will be if advertisers stick with social media due to the upswing in users during lockdown. Thus, it will be worth watching Facebook, Twitter and Alphabet’s earnings closely when they report at the end of this month. Netflix, the online TV streaming service should be another big winner, in our view, with a jump in users and a potential slump in costs as studios are forced to cancel the production of new shows. 

Retail:we believe that the retail sector will be hurt, however, those companies with a large online presence could outperform. So, H&M, Zara and Next (now that it is up and running online) may see better sales than Associated British Foods, owner of Primark, that has no online presence. Big ticket retailers like house sellers, home builders, car makers and car sales companies may get hit the hardest. We also think that this could include companies like Apple. Even though people are on their phone more during lockdown, will they be looking at buying an expensive new smartphone or laptop when 1 in 10 people in the UK could be unemployed by the end of this lockdown? 

Those companies that could do well in the lockdown include: 

Retailers:UK supermarkets, who report at the end of the month. Are expected to benefit from this crisis for obvious reasons, however, we would also expect costs to rise as they have gone on a hiring spree in recent weeks to meet demand. Online retailers such as Amazon are also likely to be major winners, based on very crude analysis (the number of delivery drivers seen by Minerva) and the record high in its share price. Amazon is still doing a roaring trade, especially in Covid-essentials like medical equipment etc. 

Healthcare:companies in this sector have had a better crisis than most, for obvious reasons. News that GSK and Sanofi are working together to find a vaccine is also good news for these companies, and GSK is one of the top performers in the FTSE 100 so far on Wednesday. It is now a race to see who will discover the first vaccine. The company that does manage to do this is likely to be richly rewarded by the stock market. 

To conclude, Q1 earnings might not look that bad on paper, but future outlooks make for some uncomfortable reading and that is what is most important for traders right now. While there are notable weak performers, there are some other sectors that could do surprisingly well out of this crisis – for example, some retailers, and some tech companies. How consumers behave during lockdown won’t be fully understood until we get company earnings for Q2, but any positive forward guidance during the Q1 earnings season is likely to be jumped on by investors and could lead to a ‘good news’ rally, albeit one that is limited in scope and duration.