Buried within a grim quarter for corporate results is a bullish trend that could explain some of the stock market’s recent resilience. An unprecedented share of companies are now predicting a brighter future.
The ratio of companies saying analyst earnings estimates are too low is 3.3 times higher than those saying they’re too high, a record, according to Bank of America data going back to 2000. It’s not being driven by a small sample, either. The gross number of above-consensus guidance was the strongest for any third quarter since 2010.
While coming amid a lot of bad news -- S&P 500 earnings are forecast to have dropped 21 per cent in the third quarter -- rising estimates from the likes of PepsiCo Inc. and Sherwin-Williams Co. are welcome to traders who spent the summer wondering where the bottom was in the worst recession since the 1930s. It’s an offset to chaos at a time when politics are whipping up price volatility and hijacking many market narratives.
“Initially there was a lot of uncertainty about what this COVID-19 meant, so now that we’re coming to grips with it, we’re understanding it a bit more, firms are getting a better handle on how to deal with it,” said Yesim Tokat-Acikel, portfolio manager and director of multi-asset research at QMA. “That is another constructive signal.”
Though not as many companies are issuing forecasts as they did in pre-COVID periods, the volume of firms offering it has picked up. More than 160 members of the S&P 500 have made such estimates in the past three months, an improvement from less than 150 earlier this year, according to BofA.
PepsiCo is an example. The company said it had a stronger-than-expected summer as consumers loaded up on snacks and beverages. It resumed offering guidance and projected organic revenue growth of about four per cent for the full year. Similarly, Sherwin-Williams boosted its forecast for both the third quarter and the full year.
Few firms were daring enough to say anything about the future back when the coronavirus crisis was peaking. By one measure, about 80 per cent of firms refused to offer a forecast in the three months through mid-summer. Foggy visibility left analysts flying by the seat of their pants and pushed some strategists to suspend their year-end S&P 500 price targets. The upside from all the ambiguity is that a record number of S&P 500 firms beat analyst estimates in the second quarter and the index kept rallying.
“Analysts as they came through the early coronavirus period set the bar incredibly low,” said Lawrence Creatura, a portfolio manager at PRSPCTV Capital LLC. “Now roll forward several months and we’re at a moment in time where reality wasn’t nearly as bad as feared.”
The flipside of that dynamic may be what the market is facing now. As guidance improves, analysts are following with earnings upgrades, potentially setting up a higher bar for companies to clear. Expected profits for the third quarter increased by 5.6 per cent to US$33.13 a share during the course of the period, the first time in two years analysts were raising estimates into reporting season.
Banks including JPMorgan Chase & Co. and Citigroup Inc. kicked off the earnings season Tuesday. Citi shares fell after costs rose and the bank warned of a slower economic recovery, though earnings topped estimates. JPMorgan also beat profit expectations.
With macro uncertainties elevated in coming months, management teams might still be reluctant to provide guidance, according to Goldman Sachs’s David Kostin. A timeline of when a vaccine might become widely available is up in the air and headway on a new stimulus package from Congress has been stymied. Those factors coupled with the upcoming elections, “are all valid reasons for executives to minimize forward-looking commentary,” Kostin and a team of strategists wrote in a report.
--With assistance from Sarah Ponczek and Lu Wang.