Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.
World stock markets generated decent returns in the third quarter of the year, as investors looked ahead to further economic stimulus measures aimed at offsetting the effects of the coronavirus1. In this environment, an historic fall in corporate earnings in the April-June quarter quickly took its place in the rear view mirror.
In the second quarter, by the way, companies provided a window on the full effects of the blast from Covid-19. The empty streets, grounded air fleets, closed entertainment facilities and low oil prices of the spring translated to sharp falls in company profits.
In the US, earnings were almost 32% lower compared with the same three-month period in 2019, with consumer discretionary, industrials and energy companies taking the biggest hits. Only the utilities, healthcare and technology sectors registered year over year earnings increases, the latter supported by positive earnings reports from the likes of Apple and Amazon2.
The picture was more severe in Europe, where earnings were 51% lower in the second quarter compared with 20193. Critically, however, results were generally no worse than feared in either place, and better than many advance estimates had indicated.
How companies performed in the third quarter could, once more, be a key determinant of the fortunes of markets as we head towards the end of the year. Should forecasts get beaten again, the barriers to a positive final three months of 2020 will be considerably lessened.
Having said that, exceeding estimates this time could be significantly harder for two reasons. Back in the spring, when the coronavirus crisis was running at its peak, sentiment was extremely poor given great uncertainty about where the Covid crisis would take us. That made it easier for companies to report earnings performances flattered by overly downbeat forecasts.
Secondly, world economies generally, but the US in particular, staged strong rebounds in May and June after a desperately weak spring. Since then, the signs are recoveries have flattened with, for example, US retail sales growth starting to slow in August4.
Both factors – overly depressed expectations three months ago and slowing economic momentum now – make it more likely that professional forecasts for the third quarter will prove closer to the mark.
The big picture is for more pain in the short term, followed by sustained growth in 2021. In Europe, that means year-on-year earnings comparisons over the next two quarters remaining in deeply negative territory, but with earnings growth returning with a vengeance by the first quarter of 20215.
The same is true for America, where two more quarters of negative growth are expected to be followed by strong rebound, albeit, in terms of easy comparisons with depressed 2020 numbers6.
Just as important as the numbers will be the outlook statements issued by companies. There remain significant earnings pinch points that will affect these.
Energy companies are likely to remain cautious about their earnings outlooks given oil prices hovering around US$40 per barrel and the continuing threat some of the stimulus governments are pumping into their economies will manifest itself in renewable investments. Adding fuel to these flames, the UK prime minister said this week offshore wind will power every UK home by 20307.
Banks, meanwhile, may report improvements due to rising corporate borrowing, but also the continuing, unwanted effects of ultra-low interest rates. Low rates press down on the gap between borrowing and lending margins.
Consumer discretionary companies are likely to say conditions remain difficult as fears intensify that more workers face unemployment over the next few months. Deep job cuts at loss-making Disney at the end of September underline the intense problem now faced by leisure companies – visitors deterred by both health fears and job insecurity.
Inevitably, earnings contributions from the technology sector will be examined closely for further signs of a heavy uptake among stay-at-home consumers and workers. Earnings at Amazon, new subscribers for Netflix and Apple’s iPhone revenues all have the potential to drive shares once again.
While the forthcoming earnings season may hold the key to equity returns this quarter, a number of other important events promise to play their part. This week, we learned that the Congressional economic stimulus package we have been waiting for – worth between US$1.6 trillion and US$2.2 trillion depending on which side of the political fence you sit – may not arrive in full until after the inauguration of the next president in January. Most seem to believe that it will still arrive though.
Meanwhile, the polling gap in the race to the White House itself seems a little clearer now than it did back in the summer, with Joe Biden having opened up a fairly consistent lead. Whichever candidate for the presidency wins, markets will be hoping for a decisive result that reduces the chance of legal challenges rolling into 2021. As with Brexit trade talks, we are moving closer to a resolution and, positively for the markets, more certainty to hang on to.
Incidentally, a strong performance from stock markets this quarter probably ought not to be ruled out on the basis that prices rose strongly between July and September. Over the past ten years, the S&P 500 Index has risen eight times during the final quarter of the year, and every time (four times) there was a positive return in the third quarter preceding it8.
Once again though, the outlook probably depends less on actual events than how expectations intersect with reality. Given that the outlook into 2021 promises to brighten considerably compared with where we are now, investors may continue to find good reason to stay optimistic about the quarter ahead.
1 MSCI World Index (USD) 30.9.20
2,6 FactSet, 2.10.20
3,5 I/B/E/S data from Refinitiv, 6.10.20
4 Census Bureau, 16.9.20
7 Gov.UK, 6.10.20
8 multpl.com, 8.10.20
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. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.