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World stock markets drew encouragement from coronavirus stimulus talks in Washington this week, with America’s NASDAQ setting new record highs and the S&P 500 not far behind1. In the background, however, the business end of coronavirus lockdowns continued to feature strongly for a corporate results season like no other in recent memory.
With businesses and consumers frozen out of many of their economic activities, oil trading mostly at less than US$40 per barrel and a rising gold price signalling caution, it will come as no surprise to anyone that company earnings faltered in the second quarter of 2020.
At this point, about one third of the results from UK and European companies are in. Healthcare, technology and telecommunications services companies have posted resilient earnings performances with healthcare actually showing a small improvement compared with the same quarter a year ago.
As might have been expected with oil prices languishing and people in lockdown, energy and consumer cyclical companies have been the worst hit. Both are showing average earnings declines of more than 100% as of now. Earnings overall are on course to be down almost 70% in the quarter2.
Just as importantly though, almost twice as many companies have exceeded consensus expectations than those that have disappointed. In holding up over the course of July, European markets have confirmed that absolute results matter less than how results compare with forecasts, at least, over the short term3.
In the US, the overall picture is similar but not the same. America has one big advantage in the current environment over Europe in that it is home to a large technology sector offering services attuned to a global lockdown.
Partly because of this the earnings decline suffered by US companies has been less severe overall than in Europe. US technology companies grew their earnings by about 1.4% over the quarter, while the same sector produced an earnings decline of around 6% in Europe. With around two fifths of S&P 500 companies left to report, US earnings are expected to be down by around 34% compared with the same three months last year4.
The resilience of stock markets this summer in the face of these earnings reports reflects a number of factors. First, as mentioned earlier, many companies performed less badly than expected over the second quarter. As in Europe, US companies have also beaten lowered expectations5. Second, companies are generally valued on the basis of their earnings over more than one quarter, allowing investors to focus on the future as well as the past.
Results from some businesses have revealed significant future potential – Amazon, for instance, with a 100% increase in net income compared with the second quarter of 2019 and future catalysts to growth including same-day deliveries to look forward to6. For many businesses that survive the current environment, the medium term future may remain highly attractive.
For some others, like BP, weak results and a dividend cut have been shaded by an opportunity to highlight the potential for business transformation. While BP’s earnings turned deeply negative over the April-June quarter, investors would have been encouraged by the publication of more details about how the company aims to reduce its dependence on fossil fuels and rapidly increase its investments in low-carbon technologies and renewable energy generation7.
There are risks to overlooking unpalatable results. With share prices holding up and earnings in deep decline, the S&P 500 Index now trades at the upper end of the range over which valuations look acceptable – at about 25 times the earnings companies are expected to make over the next 12 months8.
Moreover, several hurdles lie in wait for markets before a real recovery begins, including two further quarters likely to show negative earnings growth – albeit less severe than the contraction we have just seen – and an election in November that could quite conceivably hand the keys to the White House to Democrat Joe Biden. A Biden-led government might be strong on spending but a negative for taxes, with an uncertain outcome for US companies. That’s not to mention the possibility of a second wave of coronavirus infections sweeping the globe.
Against that, data out this week provides some comfort. The ISM services sector index jumped to 58.1 in July, signalling strengthening consumer activity in the US for a second straight month. A reading of more than 50 indicates an expansion9. This is one corporate earnings season we may be right not to dwell too much upon.
For investors, a diversified portfolio approach remains one of the best weapons against uncertainty. Multi-asset funds like the Fidelity Select 50 Balanced Fund do this well. With exposures to equities, bonds and cash, together with a wide geographic spread, these funds aim to give investors a smoother ride through difficult times. The Select 50 Balanced Fund is built predominantly from funds on Fidelity’s Select 50 list that invest across different asset classes.
More on Fidelity Select 50 Balanced Fund
1 CNBC, 03.08.20
2,3 I/B/E/S data from Refinitiv, 04.08.20
4,5 I/B/E/S data from Refinitiv, 31.07.20
6 Amazon.com, 30.07.20
7 BP, 04.08.20
8 Wall Street Journal, 31.07.20
9 Services ISM® Report On Business®, 05.08.20
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. Select 50 is not a personal recommendation to buy or sell a fund. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.