The COVID-19 related collapse in earnings will be reversed slowly as the economy re-opens and the recovery matures into expansion in 2021, causing a full recovery in the market to the February highs by the end of this year, according to Mizuho Securities’ chief economist Steve Ricchiuto.
Since nearly all the country’s economic activity has been suspended since late March amid rising concerns about the spread of the coronavirus disease, federal governments and central banks around the world has spent trillions of dollars trying to help restart the economy and provide some relief to the financial markets.
That stimulus has given the initial impetus to stock as liquidity increased in the debt markets and volatility subdued in several markets. However, the long-term impact of these massive stimuli on the economy and the financial markets is unknown. The S&P 500 has recovered more than 40% from March’s trough, closing 1% up at 3185.04 on Friday.
Based on the average change in earnings growth due to companies reporting positive earnings surprises, it is likely the index will still report a year-over-decline in earnings of more than 40% for Q2, according to FACTSET.
“Bottoms-up estimates suggest operating earnings will be down between 41% and 42% in the second quarter after having declined just 1% in the first quarter of the year. The COVID-19 related collapse in earnings is expected to be reversed slowly as the economy re-opens and the recovery matures into expansion in 2021,” said Steve Ricchiuto, Chief Economist at Mizuho Securities.
“Operating earnings are not expected to be back in the black, +1.5%, until the first quarter of next year. Earnings growth in the third quarter is expected to be down almost 23%, followed by a 10% year-over-year decline in the final three months of 2020. For the full year 2021, earnings are expected to bounce by 28.9% after a 22% decline in 2020.”
Earnings are forecast to total $127.28 billion in 2020, down from $157.68 billion seen last year, and are anticipated to recover to $162.39 billion next year. Mizuho forecasts the multiple to decline from 24.8x to 22.1x in 2021 as investors slowly realize the increased level of debt created by the COVID-19 lockdown, leading to a shallow 2%-2.5% expansion.
Several equity analysts advise keeping a close eye on companies whose stock prices have fallen substantially along with others in the wake of the coronavirus pandemic, yet whose underlying fundamentals remain strong and are expected to strengthen.
“These bottoms-up earnings estimates and our assessment of the nature of the recovery has caused us to revise upwards our year-end target for the broad market index from 3200 to 3400. Essentially, we now expect a full recovery in the market to the February highs, not just to 2019 year-end close. In 2021, we are calling for a 6% rise in the S&P 500 to 3600 based on our shallow expansion call. Our relatively cautious expansion forecast is based on the fact that although a credit dislocation did not push the economy into recession, the need to repair balance sheets will likely sidetrack investment spending,” Mizuho’s Ricchiuto said.
“A fiscal policy push into industrial policies and/or infrastructure spending could cause us to reconsider this macro forecast but, with the U.S. election and congressional summer recess rapidly approaching, the window is rapidly closing for a phase IV stimulus bill to be negotiated and passed. The uncertainty created by the rise in COVID-19 cases being reported is likely to keep the market trading within a 3000 – 3200 range for the next several weeks,” he added.