April brought some stabilisation for risk assets, with investors consoled by monetary and fiscal support that borders on the brink of “unconditional”. Equities rekindled about 25% of their losses from the February/ March bear market sell-off, despite a slate of horrible economic data and a precipitous drop in oil prices with supply still out of sync with dwindling demand (WTI futures prices even turned momentarily negative with holders unable to take delivery due to a lack of storage space in the US).
Towards the end of the month, Q1 earnings season kicked-off. Its collision with the coronavirus means that all we come away knowing is that we don’t know what lies ahead as the world grapples with a simultaneous supply and demand shock. For the first time ever, the most important metric analysts should be looking at is for how long the company can survive without sales (as is the case for many) and the current cash level on the balance sheet. Wave goodbye to the exponential balance sheet optimization of the past decade.
“IBM is withdrawing its full-year 2020 guidance in light of the current COVID-19 crisis.” –IBM
“Given the great uncertainty of the current environment, we feel it’s prudent to hold off providing fiscal year 2020 guidance.” –Coca-Cola
“Due to the lack of visibility related to COVID-19 pandemic and recovery, the Company has withdrawn financial guidance at this time.” –AT&T
“Due to the rapidly evolving situation and the high degree of uncertainty, we do not believe we are able to estimate the full-year financial impact with reasonable accuracy and, therefore, believe it is prudent to withdraw our fiscal 2020 full year guidance at this time.” –Hershey
Pulled guidance is the dominant theme of the current earnings season. Above, is only a handful of the many companies that don’t feel well placed to offer the investment community estimates about future earnings, with the pandemic having plunged us into unparalleled economic uncertainty.
We face a host of unknowns and CEOs and CFOs are as much in the dark as anyone.
We face a host of unknowns and CEOs and CFOs are as much in the dark as anyone. No one knowns when the rate of new infections will peak or how long the development and deployment of a vaccination will take. No one knows how businesses and consumers will behave after lockdowns are lifted. Will consumer demand snap back? What will be the pace of business recovery? Will laid off staff be put back on the payroll?
Amid the uncertainty, analysts have been dialling down their expectations for 2020 earnings growth drastically. By travelling in the opposite direction to equity prices, from a valuation perspective, these revisions have made equities just as expensive as they were in February before the coronavirus crisis proliferated. But investors don’t seem to be fundamentally driven at the moment. Market spirits are running high on the prospect that stimuli packages will be sufficient to support the survival of companies and to get the economy back on track again in 2021. Actually, the consensus believes that earnings will grow 23% in 2021 compared to 2020. This could be plausible because 2020 will surely be a low hurdle to overcome. However, that number also indicates that as of now, earnings should grow 5% in 2021 compared to record 2019 numbers and absorb the losses from 2020 as well. If we look at the S&P 500, after a recession, it normally takes 3-4 years before earnings are back at the same level as before (as seen in 1987, 2001 and 2008). But again, this is a very rare man-made recession with a potentially strong rebound.
One thing we can be quite sure of is that volatility is here to stay for a while.
One thing we can be quite sure of is that volatility is here to stay for a while. With all this in mind, we still prefer large-cap quality names with strong balance sheets, high free cash flow and cash yields that are in a relatively better shape to withstand the current uncertainty. Those companies will have the ability and the flexibility to figure out their future: Endurance is currently crucial. We don’t hold a specific sector preference, rather, we filter for company specific criteria across sectors. This is largely because there are quite big deviations inside sectors: Sub-sectors like remote working, cloud, e-commerce, streaming, telemedicine that were already secular plays, are accelerating due to the crisis.
To end on a positive note, this earnings season may just be the catalyst that pushes the financial system towards adopting a longer-term mind-set while the world slowly shifts away from shareholder capitalism towards a new paradigm of stakeholder capitalism. Two years ago in a joint op-ed, JP Morgan CEO Jamie Dimon and the renowned investor, Warren Buffett, urged public companies to stop providing quarterly earnings guidance, arguing that it promotes short-term profits over long-term sustainability, with companies managing to a number, not investing for the future. Thus far, the old chestnut about markets abhorring uncertainty certainly isn’t apparent in equity prices.