22 Jul The great earnings conundrum
Following our ‘bumper edition’ a fortnight ago, this latest bulletin has a more slim-line feel about it. That there is nothing much to write about could not be further from the truth. We are currently working on the half-yearly Profile Reports which will provide a far more comprehensive review of the markets and the performance of all CDC portfolios, so at the risk of overkill, we have kept this update brief. The Profile Reports will be issued toward the end of July.
The great earnings conundrum
Very early on in these updates we said the market would respond to this crisis in three broad phases – panic, stabilisation and recovery. Using the FTSE-100 as a barometer, and of course with the benefit of 20:20 hindsight, the panic phase looks to have been triggered on 24th February and ran for exactly a month. The market sold down on large trading volumes and from peak to trough the index had fallen 32%, the most rapid decline of this size in history.
At that time, our message to investors was clear, sit tight. Whilst CDC customers universally kept their nerve, many didn’t. An article in the Wall Street Journal suggests as many as a third of all retail investors over the age of 65, sold out between the start of the slide and May. Across all age groups as many as 18% went entirely liquid, mirroring a tendency the investment community has seen many times before. The UK index is now 7% up from its position at the start of May and fully 26% higher than the low-point.
In our view we are still in the stability phase. Again using the top 100 UK companies as a yardstick, we have to go back to early June to find a day when the index was outside the 6000-6300 trading range, so during this period share prices have been remarkably stable.
So the question is when will we see the recovery stage start? This is a little bit more tricky to answer, and depends on geography to a large extent but we may get more clues from this summer’s reporting season. Stock markets are ultimately driven by the notion that companies make higher and higher profits each year and reward shareholders with progressive increases in dividends, so any recovery in share prices needs to be hand in glove with good corporate profits. Or does it?
We know that COVID19 has hit the world economy hard. The Investment Committee at CDC are probably sick of hearing me say ‘the data doesn’t matter’. I say this not in a glib way, but merely to illustrate that the economic data this year, particularly quarter 2, is going to be poor. Extremely poor. That will hurt company earnings and many have withdrawn dividends as a consequence. Taking this to a logical conclusion, as we get into reporting season, we know company earnings are going to reflect the harsh reality of the economic environment. But there will be exceptions and we see 3 categories of company holding up particularly well:
- Working from Home – the likes of Google or Microsoft
- Deliver to Home – Ocado, Amazon
- Fun at Home – Netflix, Tencent
So in summary we see three key themes investors will be watching for in the reporting season. The first will be how well ‘new economy’ earnings have advanced. This will matter more to the US stock market as it is naturally more technology laden than its UK or European peers. Second is the extent to which companies ‘kitchen sink’ the accounts, or put another way, throw all bad news and provisions into a set of accounts that they know will be suffering anyway. Finally, and this is absolutely key to the recovery phase of the market, forward guidance. If CEOs generally say the worst is behind them, the supply chain is intact and the order books are filling, this could be enough to provide share prices with more impetus.
Some commentators have said, given results are going to be poor and that is a given, this reporting season is one of the least important. We beg to differ …….
Dr Andrew Mann