Asian and European equities along with US futures rose ahead of what is expected to be a busy week on all fronts. While market watchers will keep an eye on the global rise of COVID-19 cases, central banks in Europe, Japan and Canada will provide some insight into whether cheap liquidity will continue to flow over the foreseeable future. China’s GDP is due to be released on Thursday and is likely to mark a steep recovery from the 6.8% contraction in the first quarter, and EU leaders gather on Friday to determine the fate of an ambitious recovery fund. There will also be several pieces of US data that will indicate whether the rebound in economic recovery remains in place. However, it is the earnings season that is likely to determine if stocks continue to move higher from current levels.
According to Factset, the S&P 500 is expected to report a decline of 44.6% for the second quarter. Assuming the aggregate earnings beat forecasts by 5%, the index will still end with a 39.6% fall in profits. Even the most optimistic scenario will show the largest year-on-year decline in earnings since the Great Financial Crisis. If investors were taking the loss in Q2 earnings and revenues into consideration, it follows that stocks should not be trading at current levels. In fact, investors are looking post-Q2 with the hope that lost revenue will be recovered in the second half of this year and into 2021. That is the V-shaped recovery every stock market bull is betting on.
What CEO’s say on earnings calls will be of greater influence than what the numbers say. In the last quarter, only 10% of S&P 500 companies issued EPS guidance compared to an average of 20%. Given that we are already more than six months into this pandemic, corporate leaders should have more clarity on how their businesses will operate over the second half of the year. To keep the bull market alive, it requires an optimistic tone reflecting the V-shaped recovery that confident investors are looking for. That is especially the case for Tech stocks that have led the surge in equities. If investors sense the V-shaped recovery in earnings is misplaced, expect companies with extreme forward P/E ratios and those with weak balance sheets to be punished the most.
Monetary policy, the key driver to market performance over the past several months, will gradually lose influence to the earnings outlook. After all, prolonged low-interest rates are already baked into asset prices and that is evident in most valuation metrics you look into. Meanwhile, the chances of Joe Biden winning the upcoming US election and reversing some of Trump’s tax reforms is the other risk which does not seem to be priced into markets yet. Even a limited reversal in the 2018 corporate tax cuts will have an impact on investor sentiment, given the levels where stocks are currently standing.
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