Q2 EARNINGS SEASON: Y-EARNING FOR CLARITY


Wei Li 31/Aug/2020

Keep it brief

  • Earnings have contracted at their fastest pace since the global financial crisis (GFC), but muted expectations ahead of the Q2 season meant a low bar to clear, resulting in strong levels of earnings beats.
  • Defensive and quality sectors have reported the strongest earnings per share (EPS) growth in both regions, while cyclical sectors such as energy, materials and industrials have reported the greatest fall in earnings.
  • Around 40% of US firms have upgraded their forward earnings guidance for Q3 and only c.10% have downgraded forecasts, suggesting that, in line with our view on the Covid-19 growth shock, the sudden and unprecedented drop in earnings is unlikely to develop into a protracted trough.

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After a first quarter earnings season that was too early to reflect the full impact of Covid-19 – particularly in the US, where lockdowns came later than in Europe – and also provided little guidance on future earnings, all eyes have been on the Q2 season for more clarity. While the outlook remains uncertain, a few trends have emerged.

A record fall

As expected, Q2 earnings per share have fallen significantly in the US (-33% YoY) and Europe (-26% YoY), with both regions registering their largest post-GFC earnings contractions.1 Despite the overall drop in US earnings, the percentage of companies beating forecasts has reached its highest level since 2009, albeit against a diverse but broadly depressed range of analyst expectations heading into the season. European earnings were also given a low bar to clear, again resulting in strong levels of earnings beats in Q2.

While market reaction to US earnings releases has been muted on the whole, with neither upside nor downside surprises triggering significant share price moves, the story has been slightly different in Europe. Given the very low expectations for European corporate earnings, beats have not been rewarded, while misses have been punished at the highest level since Q3 2019, with a median stock price fall of 1.8% on the day of a miss.2

European stock one-day price reaction to EPS beats/misses, Q1’16 – Q2’20

European stock one-day price reaction to EPS beats/misses

US stock one-day price reaction to EPS beats/misses, Q1’16 – Q2’20

US stock one-day price reaction to EPS beats/misses

Source: Bloomberg and Barclays Research, as of 6 August 2020.

While overall earnings have fallen by a similar amount in the US and Europe, there has been regional disparity in top-line sales figures, with Europe’s earlier, more stringent lockdowns feeding through to a -24% fall YoY for European companies, compared to -11% for US firms.3 While this may look extreme at the headline level, the level of fiscal and monetary support introduced in Europe – the European Recovery Fund being the latest example of this – should help European sales to recover, and consumption has started to pick up faster in Europe than elsewhere in the world.

With Europe remaining further ahead in its easing of lockdowns and managing breakouts better than other regions, and with delays to fiscal support and the November election posing risks for US assets, we continue to favour European equities – but second wave risks mean we remain selective in both regions, preferring a tilt towards quality companies that have proven able to grow earnings in Q2.

1 Source: Bloomberg and J.P. Morgan, as of 6 August 2020. US figures based on S&P 500, European figures based on Stoxx 600.
2 Source: Bloomberg and Barclays Research, as of 6 August 2020.
3 Source: Bloomberg and J.P. Morgan, as of 6 August 2020. US figures based on S&P 500, European figures based on Stoxx 600.

Sector selection remains key

Delving below the headline figures in the US and Europe, defensive and quality stocks – those that display characteristics such as high return on equity, high free cash flow yield and low beta-to-GDP – have unsurprisingly reported relatively strong EPS growth. The healthcare, information technology and utilities sectors have posted the strongest earnings in Q2. This may also be attributed to factors such as tech firms being better-positioned to transition to a remote-working environment, and increased focus on healthcare stocks given the nature of the current crisis. On the other hand, weak earnings growth from sectors such as energy, materials, and industrials has led to cyclical stocks registering a -40% YoY earnings drop in the US and -17% in Europe, reinforcing the need for selectivity in equities.4

Growth in Q2 earnings per share by sector, % YoY

Growth in Q2 earnings per share by sector, % YoY

Source: Bloomberg and J.P. Morgan, as of 6 August 2020. US figures based on S&P 500, European figures based on Stoxx 600.

4 Source: Bloomberg, as of 11 August 2020. US figures based on MSCI USA, European figures based on MSCI EMU.

Third quarter rebound?

This earnings season was unique, as the absence of coherent forward guidance from the previous reporting season heightened uncertainty – especially as Q2 covered the most stringent lockdown periods in Europe and the US. Looking ahead, consensus expectations are for earnings to recover from this perceived trough in Q2, with a more substantial recovery – and a return to positive EPS growth – forecast for 2021. This has been reflected in forward guidance from the US, with firms reintroducing Q3 and full year forecasts, and many anticipating a rebound: around 40% of US firms have upgraded their Q3 guidance while only c.10% have downgraded forecasts.5 Although the relative lack of forward guidance has made it harder to discern a trend in Europe, the tone of reports has improved across both regions, with activity recovery driving a more optimistic outlook. We have seen this come through in the pace of earnings revisions, which far outstrips the post-GFC recovery, and may be indicative of a faster return to trend growth off the back of unprecedented policy support.

Pace of rebound in earnings revisions, Covid-19 shock vs. Global Financial Crisis

Pace of rebound in earnings revisions, Covid-19 shock vs. Global Financial Crisis

Source: Refinitiv Datastream, as of 31 July 2020.

5 Source: Bloomberg, as of 11 August 2020. US figures based on MSCI USA, European figures based on MSCI EMU.

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