Written by: Ken Frey, VP, Corporate Credit Analyst
Corporate earnings season is more than half over and not as bad as feared.
Overall, revenues are down 12% and earnings 10%, but generally there have been more positive earnings surprises than normal. Getting the call right on revenues and earnings is difficult this quarter as most companies suspended guidance at the end of the first quarter and have yet to put their forecasting toe back in the water.
It is hard to fault the forecasting caution of management teams. As Federal Reserve Chair Powell said last week, the economy’s direction depends on how COVID unfolds, and predicting this pandemic has proven difficult as both the science and the political response are still unfolding.
What has unfolded are notable earnings takeaways in the banking, energy and technology sectors. US banks took heavy credit loss provisions, which hurt earnings. But from a bondholder’s perspective, it is more important to note that capital and liquidity are strong, and banks should come though the pandemic in good fiscal shape. Energy companies have been hit with over supply and far less demand. While it will take some time to work down higher inventories, it is anticipated that demand will outstrip supply over the next few quarters, and if oil stays around $40, the large players will limp on through to a slow recovery. Technology companies just reported last week and by most accounts it was a blow out quarter – great for online sales, but as we know this comes at the expense of brick and mortar retailers.
Corporate earnings are helped by three tailwinds: a weaker dollar, low interest rates and a massive government fiscal response to the recession. The corporate index (which closely matches the S&P) will likely continue to benefit from higher overseas profits as the dollar weakens and low interest rates reduce the interest burden for many companies. And massive government spending supports consumption and helps to take some of the sting out of this recession.
Looking to the future it is good to have tailwinds, but corporate earnings will be pushing a large stone uphill for a while longer until this pandemic is beat and the economy returns back to normal. During this time leverage will increase, which will cause credit ratings downgrades for those unprepared for bad times. As usual, good quality and selection matter.
Sources: Bloomberg, The Federal Reserve, Company Reports as of July 31st, 2020
Note: The mention of specific sectors does not constitute a recommendation and is not intended as investment advice or to predict or depict performance of any investment.
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