Corporate Profits Fall Off a Cliff
In my callow youth, when I was an overly caffeinated, overly ambitious newspaperman, the city editor gave me some advice that I never forgot: “Son, the only way to look at a politician is down.”
When will the stock market start to recover? For clues, don’t turn to political rhetoric. Turn to simple arithmetic.
Stock prices reflect expectations for future corporate earnings growth. Largely due to the coronavirus pandemic, earnings expectations for the first and second quarters have plunged. The pandemic shows no signs of abating in the United States. In fact, it’s getting exponentially worse.
The U.S. now counts more than 4,000 deaths from the virus. That’s greater than the number who died in the Sept. 11, 2001 attacks. China, with more than four times America’s population, has racked up about 3,300 deaths so far.
COVID-19 is three times more infectious than ordinary flu. By looking at the startling jumps every day in infections and deaths, many people are learning the true meaning of the word “exponential.” As business activity gets clobbered, quarterly earnings are suffering collateral damage. Let’s do a deep dive into the math.
The bear comes out of hibernation…
The first quarter of 2020 is officially in the books. Younger investors who have only known a bull market got a rude awakening.
The S&P 500 fell 20% in the first three months of 2020, its worst first quarter ever and its biggest quarterly loss since 2008. The Dow Jones Industrial Average also posted its worst Q1 performance in history, shedding more than 23%. The tech-heavy Nasdaq fell more than 14% in Q1.
Volatility has been extreme in recent days, as news about the pandemic has gotten progressively worse:
Earnings projections offer no solace. According to research firm FactSet, the data provider for Investing Daily, for the first quarter of 2020, the estimated earnings per share (EPS) decline for the S&P 500 is -5.2%.
If -5.2% turns out to be the actual decline for the quarter, it will mark the largest year-over-year decline in earnings reported by the index since Q1 2016 (-6.9%).
On December 31, the estimated earnings growth rate for Q1 2020 was 4.4%. All 11 S&P 500 sectors have lower growth rates today (compared to December 31) due to downward revisions to EPS estimates.
All 11 sectors have recorded a decrease in expected EPS growth since the start of the first quarter due to downward revisions to earnings estimates, led by the energy sector.
The oil patch falls gravely ill…
Among the 11 sectors, energy has recorded the largest decrease in expected earnings growth since the start of the quarter (to -36.1% from 29.6%).
The price of crude oil has fallen by about 63% since the start of Q1. The global coronavirus outbreak has slammed oil prices, as the deadly illness dampens travel and economic activity, in turn undercutting demand for fuel.
The price of West Texas Intermediate currently hovers at $20 per barrel, a level not seen in a generation. Ordinarily, consumers would benefit from crude’s decline. But lower prices at the gasoline pump don’t matter much, when quarantined people have nowhere to drive.
Don’t just blame the coronavirus pandemic. The dismal performance in energy has been a long time coming, due to reckless overproduction in the U.S. shale patch and strategic missteps by OPEC and its partners.
According to the Institute for Energy Economics and Financial Analysis, the energy sector was “far and away the worst performer of the S&P 500 over the past decade, placing dead-last among all sectors for stock price returns in both 2018 and 2019.”
The Saudi-Russo oil price war doesn’t help matters. Typically, if crude sinks too low, the economy and broader stock market suffer.
For Q1 2020, 72 S&P 500 companies have issued negative EPS guidance and 32 S&P 500 companies have issued positive EPS guidance.
Over the past few weeks, analysts have dramatically reduced earnings estimates for Q2. Since March 1, estimated dollar-level earnings for the S&P 500 for the second quarter have decreased by $49.6 billion (to $319.6 billion from $369.2 billion).
Into the abyss…
As a result of these downward revisions to estimates, the S&P 500 is now projected to report a year-over-year decline in earnings of -10.0% for the second quarter, compared to expectations on March 1 for earnings growth of 3.9%.
The following chart shows how Q2 earnings expectations have tumbled off the edge:
If the index reports a year-over-year decline in earnings of -10.0% in the second quarter, it will mark the first time the index has reported a double-digit (year-over-year) decrease in earnings since Q3 2009 (-15.7%).
Five of the 11 sectors are now projected to report a year-over-year decrease in earnings for the second quarter: energy (-92.6%), consumer discretionary (-31.6%), industrials (-26.8%), financials (-9.5%), and materials (-7.4%).
Earnings numbers are where the rubber hits the road. The latest evidence suggests the road will remain rough into the foreseeable future.
The three main U.S. stock market indices Tuesday closed sharply lower. On Wednesday morning, the three indices opened deeply in the red.
Don’t get fooled by temporary rallies. Unless the virus is contained and the earnings picture improves, the stock market’s downward momentum won’t end anytime soon.
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John Persinos is the editorial director of Investing Daily. You can reach him at: email@example.com