S&P 500 Index: Second quarter of 2020 to mark a low point for earnings – JP Morgan

Equity markets have rebounded quickly from their March lows on the back of the unprecedented fiscal and monetary policy response. The second quarter of 2020 should mark a low point for earnings while corporate guidance should gradually return, which could help investors set realistic expectations for the second half of 2020 and 2021. In the meantime, economists at JP Morgan are inclined to embrace more cyclicality in portfolios.

Key quotes

“In the long-run earnings will need to catch-up or prices will need to move lower, but in the interim, an aggressive and coordinated policy response has supported risk assets.”

“The second quarter should mark a low point for earnings, as margins collapsed and revenues came under significant pressure. With that in mind, and 122 companies reporting earnings (28.5% of market cap), our current estimate for 2Q20 S&P 500 operating earnings per share is $22.29, a -44.5% decline from a year prior. However, we have seen a 5-year high 80% of companies beat earnings estimates and 66% of companies beating revenue estimates, suggesting that the bar for 2Q profits may have been set too low by analysts.”

“In the event of a Democratic sweep, the corporate tax rate could increase to a top rate of 28% as proposed in campaign documents. We estimate this would bring the effective tax rate for S&P 500 companies from 17.6% up to 23.5% and, if implemented in 2021, would change our current forecast of $155 for 2021 earnings per share to about $140 per share.”

“With international economies handling the virus far better than the US and the potential for further US dollar weakness going forward, we are inclined to take on a bit more value exposure in portfolios. A global reflation trade would support some of the sectors that have been hit the hardest over the past few months, and valuations are attractive; the industrial and financial sectors look particularly interesting.”

“At the end of the day, we recognize the structural tailwinds for sectors like technology and healthcare and want to be measured in how we embrace cyclicality. Demographic tailwinds will support spending on healthcare, and the role of technology in our lives will continue to increase. The key will be to focus on those companies that will be able to generate sustainable earnings growth going forward, as those that cannot will be left in the lurch when policy support eventually begins to fade.”