Expect Q2 Earnings to be Horrible: What That Means for the Stock Market?

The U.S economy was in a great spot prior to 2020, then Covid-19 quickly disrupted its course. The virus created new operational challenges for many companies, ultimately hindering a large percentage of the economy. As many companies either closed or operated at a limited capacity, it is easy to understand why their earnings would deteriorate.  

So let’s discuss first quarter earnings, what analysts are anticipating moving forward, and how earnings affect the stock market.

 1st Quarter Earnings

For Q1 2020, the earnings decline for the S&P 500 was -13.6%. This was a fairly large decline when compared to the -0.40% reading in Q1 2019.  Earnings estimates for Q2 are going to be horrible, showing an even steeper decline.

2nd Quarter Earnings/Moving Forward  

According to FactSet,  

“For the second quarter, S&P 500 companies are expected to report a decline in earnings of -43.8% and a decline in revenues of -11.2%. For Q3 2020, analysts are projecting an earnings decline of -25.2%, and for Q4 2020, analysts are projecting an earnings decline of -12.7%” 

Overall, for the current year, analysts expect an earnings decline of -21.4% and a revenue drop of -3.9%. It is important to note, earnings growth is not expected to improve until 2021.

How Do Earnings Impact The Stock Market?

To start, earnings play a significant role in assessing the profitability of a company. Earnings are also a major factor in determining the value of a company’s stock price. By reviewing current earnings and future forecasts of earnings, investors can determine a reasonable value of a company.

Very simply, an investor should expect a company’s stock price to move higher if they are growing their earnings. On the contrary, an investor should expect a company’s stock price to move lower as earnings decline. Stock earnings, often referred to as a lagging indicator, show performance for the past quarter.  Investors have a tendency to be forward looking and want to know what lies ahead. If investors determine future earnings will increase, they buy stocks.  Likewise, if the economy and earnings are slowing, investors sell stocks. We can research this further. 

If you look at how the market moved in the first half of this year, investors experienced a severe market pullback followed by a steep V-shaped recovery. Once Covid-19 hit, investors quickly recognized the economic damage the virus would have on the economy.  Therefore, a re-pricing of all stocks occurred. Investors were anticipating lower revenues and earnings in the future (forward looking). This is why we saw the S&P 500 drop roughly -35% in Q1.

As we enter July, companies will begin reporting their actual earnings for the 2nd quarter. Investors will soon learn the real damage done by the virus on corporate profits. As previously stated, the news is expected to be bad. Yet, where is the stock market? The stock market has recovered and is near all-time highs. To borrow a slogan, the bad news is already “baked in the cake.” The reason the stock market has moved higher is because investors are looking ahead. Investors are not as interested in Q2 earning, but are now looking toward the end of the year. Investors are much more optimistic about the re-opening and recovery.

What is important moving forward is for earnings to continue to improve. Eventually, we want to see sustainable earnings growth in 2021 and beyond. Investors will still be confronted with bad news which may cause an increase in volatility. Yet, over time, stock prices should ultimately respond to increased future earnings growth. Remember, time in the market is more important than trying to time the market.

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