Running on Faith – are stocks discounting too powerful an earnings recovery?
Thanks to the grave uncertainty unleashed by the pandemic, nearly half of S&P 500 companies have withdrawn full-year earnings per share (EPS) guidance; so analysts have been flying a bit blind during the pandemic. About 130 of the S&P 500’s companies have reported second quarter earnings, and while weakness has shown itself in a few areas of the stock market; in general, earnings season has been better-than-expected. But we shouldn’t conflate better-than-expected with strong. Yes, 80% of companies have beaten analysts’ expectations (as per Refinitiv); but the expected decline in earnings for the second quarter is currently -40% (representing the blend of actual results for companies having reported and expectations for subsequent reports). It’s not a stretch—at least from my perspective—to think that the market’s move may be discounting too lofty a coming recovery in earnings.
In terms of valuations, the significant move up off the March 23 S&P 500 low has been a price/earnings ratio (P/E) driven surge; not an earnings-driven surge. From a recent low of 13.1 on March 23, the forward P/E for the S&P 500 has surged to 21.5. That is getting eerily close to the P/E highs of the late-1990s into the market’s bubble peak in 2000, as you can see in the chart below.
Source: Charles Schwab, FactSet, as of 7/24/2020.
Too much hype in too few stocks?
The Top 5 have ruled – Apple, Microsoft, Amazon, Facebook and Google
Source: Charles Schwab, Bloomberg, as of 7/24/2020.
Because these stocks are so dominating within the S&P 500, the index itself can close significantly higher at the end of a trading day even when most of the index’s stocks are declining. I do think there is a lot of risk of the aforementioned concentration.
The rally off the March 23rd Covid Crash low has been a three-act play. Act I was led by Tech and Health Care and ran from March 23rd through mid-May. Act II began when states started opening up again in mid-May and saw a rotation in the market into “re-open” stocks such as airlines, banks and industrial companies. During Act III that began on June 8th and looks to have ended on July 20th, the S&P 500 was almost exactly flat. This came during a period of rising Covid case counts around the country that caused “re-open” stocks to fall significantly while Tech and “Covid Economy” stocks led. Because some of the most notable “Covid Economy” stocks are also the biggest stocks in the world, these names helped prop up the cap-weighted S&P 500 during Act III. Underneath the surface, however, the market was very weak during Act III with the average stock in the S&P falling 5.7%. So Act III was essentially a “flat” pullback if you’re looking for a way to describe it at the index level.
Another concern is the continuing spread of Covid-19 around the country. In March it was centered in the Pacific Northwest and the Northeast. Since May, these areas have seen declines while the Southeast and Southwest have seen major spikes. In the last couple of weeks, Florida and Texas are finally slowing the spread but now the Midwest is seeing an increase in cases. Some of the increase in cases is due to better and more testing but clearly the virus is not being contained as states open up. Perhaps more concerning than the increase in cases is the change in the trend of actual deaths from Covid-19. As the chart below shows, deaths were on a steep decline from mid-April through mid-July, but have now started to increase alarmingly.
These geographically shifting outbreaks of the virus and rising death counts have forced a slow-down of the re-opening of the economy. This couldn’t come at a worse time as the benefits from the first government stimulus package expired at the end of July and Congress has not been able to agree on additional stimulus. While I am certain Congress will get some kind of deal done (it would be political suicide to not) the longer they take, the greater the potential the economic recovery stalls out.
We remain cautious at this time but have been using pullbacks to phase back into stocks where appropriate.
August 2020 Calendar of Events (comments and suggestions always welcome)
August is National Immunization Awareness Month – How ironic given the Covid-19 virus and the need for a vaccine.
August 8th My birthday!
August 13th International Left-Handers Day
August 16th National Tell a Joke day – we can all use some humor these days
August 26th Women’s Equality Day – as the son of a single mom and the father of 3 wonder young women, I support improving equality for women in all areas.
August 26th National Dog Day – shout out to all the dog lovers out there – woof!
Please stay safe and well.
Sources: Charles Schwab, Bespoke Investments, CNBC.com
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