Earnings defying pessimistic forecasts
We’ve had a big week for US companies reporting their earnings for Q2, and expectations were that the lockdown-induced recession would cut 11% off revenues and a massive 44% off earnings for S&P 500 companies compared with this time last year. Some highly regarded analysts were even more pessimistic with a 60% drop in earnings. Based on last week’s reports, numbers are coming in much better than expected. Close to 80% of S&P 500 companies are beating forecasts. We still have the bulk of companies to report, but it does reflect the improved news flow in recent weeks.
Despite this, markets are looking ahead to the damage from the US second wave and the fact that in Europe and Asia – which have both avoided serious second waves so far, lockdowns are being eased only gradually.
Europe PMIs could be stronger than the US
Europe has suffered a deeper recession from the virus than the US, partly because the lockdown was more strict and partly because the US fiscal and monetary response was much bigger. Does this mean a weaker European recovery than the US? Not necessarily – the better virus management could well mean the opposite. The July Purchasing Managers’ Indices (PMIs) are out towards the end of this week and we expect them to show strength in Europe – stronger than the US.
But that doesn’t mean the stock market will outperform. Europe doesn’t have the mega cap growth stocks like the US, and it has a much bigger financial sector that is still struggling. Plus the euro has been strengthening and that eats into earnings. We think that the US still has the edge over other markets despite the damage from the second wave.
US politicians get it wrong
Just over four weeks after Vice President Mike Pence’s spectacularly badly-timed Wall Street Journal op-ed, entitled “There Isn’t a Coronavirus Second Wave”, the US recorded almost half a million new cases in the week ended Saturday; easily their worst week and more than double the worst single week in the first wave back in April. We are focusing on hospitalisation numbers to gauge which states are getting on top of the problem and when they might emerge from lockdown. The numbers have clearly peaked in Arizona – once the worst affected of the sun belt states – so they could start exiting lockdown in August. The numbers are flattening in Texas and California, so we anticipate them exiting in September or October. Florida is still a mess; we don’t entirely understand why.
But what of the damage that this is doing to the US economy overall? The PMIs will give us an indication, but I’d take a close look at initial unemployment claims on Thursday. There’s a close relationship between bad virus data and weakness in the labour market, and this is the week that the monthly payroll numbers are surveyed.
Hopeful for continued political support
Which brings us to the ticking time bomb on the $600-a-week that the Federal government is paying to the unemployed. That’s a massive support – more than average wages in most US states – and it expires at the end of the month. Congress is currently debating proposals to extend that payment, at a reduced rate with an additional boost perhaps from a cut in payroll taxes. It they come up with a package of over $1.5 trillion, the market will be pleased. If they let unemployment benefits lapse completely, even for a few weeks, that would be very bad news. We are optimistic, but predicting politics is never easy.
Potential vaccine is positive for the UK but there are headwinds
Here in the UK, things are starting to get back to normal, and there is a lot of pessimism around our economic performance, with fears of mass unemployment when the furlough scheme starts winding down next month. Despite this, I’m hopeful that the economy will beat deeply pessimistic forecasts. If there’s good news on the vaccine, the UK should be one of the first countries to see mass vaccination. This would be positive for UK markets, although there are headwinds: near term due to the negative affect of deteriorating relations between the UK and China, and longer term due to our massive current account deficit.
Equities still look set to outperform
I still think equities will outperform – don’t expect big returns, but they look set to be bigger than bonds, which will struggle to beat cash, which only delivers either side of zero depending on the currency.