September 23, 2020

The first two quarters of 2020 have been characterized by earnings reports unlike any we have seen in recent history. We finished 2019 with corporate earnings at an all-time high, only to see them plunge in the first half of this year. Despite the sharp decline, the stock market has rebounded dramatically from the lows and it reached a new high in early September. In order to provide some context to the market’s rebound and the performance of various segments, we have summarized the earnings results, guidance, and commentary from some of the company management teams.

Unsurprisingly, many companies posted sales and earnings results for the first three months of the year that were far below expectations. During the associated earnings calls, management teams that provided guidance metrics for the second quarter set the bar low, not having the visibility needed to precisely forecast the trajectory of their business in the COVID-19 era. In total, forward-year earnings per share estimates for companies in the S&P 500 were revised down about 15 percent as first quarter guidance reflected significant uncertainty.

The second quarter was weak, but results were better than expected. Companies in the S&P 500 reported sales that were nine percent lower than a year ago and earnings that were nearly seven percent lower. Although these figures are poor in an absolute sense, many analysts had expected an even worse outcome. In fact, 84 percent of S&P 500 companies beat analyst estimates for earnings, reflecting the caution expressed in the first quarter, the associated low expectations, and an improving environment.

Second quarter earnings announcements also provided an opportunity for companies to update their plans and provide guidance to the extent possible. Some companies continued to eschew giving guidance, while others felt they could give a preliminary forecast of their outlook for the rest of the year. Importantly, nearly all management teams commented on the “positive linearity” of improving trends in their businesses as they progressed through April, May, June, and July.

Although business activity has undoubtedly improved from exceptionally low levels in March and April, companies in certain industries have benefited more than others. For example, technology companies have reported remarkably resilient revenue trends as both work and leisure activities have migrated to the cloud. Technology—both hardware and software—has clearly taken a more central role in daily life for many people during this era. By some estimates, two years’ worth of e-commerce growth has taken place since the start of the pandemic. In the second quarter, e-commerce grew 44.5 percent year over year, to about 22 percent of total retail sales. Unfortunately for small businesses, most of these changes have benefited large, established retailers with sophisticated e-commerce and delivery capabilities. Reflecting the disproportionate benefit to large technology companies, a surprisingly high 93 percent of technology companies beat earnings estimates in the quarter.

Other changes in consumer habits include a spending shift away from travel, hotels, and airlines, but toward home-related projects and other health/wellness purchases. As trips were canceled, discretionary dollars were shifted toward items including exercise equipment and food prepared at home. Furthermore, consumers have turned their attention to their dwellings, where there has been a renewed interest in spending on home improvement as well as buying new homes. Homebuilders have reported historically high levels of order growth, in excess of 50 percent year over year in some cases, and buyers have started to embrace the idea of tolerating a longer commute in exchange for more space. Accordingly, the NAHB Homebuilder Sentiment survey reached a new record high in September.

As expected, many cyclical industries reported poor results. Overall, energy, industrial, and financial companies reported results that were down significantly from the prior year. Each of these industries was negatively impacted by the COVID-19 outbreak, but some also suffer from unique factors. For example, the energy industry continues to suffer from excess capacity which exacerbates their recovery efforts, and banks are struggling to generate net interest income growth in the current environment of low interest rates. Despite these challenges, results across the cyclical segments were better than expected.

In health care, companies that produced COVID-19 supplies or testing or diagnostic equipment experienced notable growth in revenues, while other health care companies that focused on elective procedures struggled. Understandably, many elective surgical procedures were delayed as a result of the outbreak, but recently we have seen evidence of some resumption in this area. Conversely, the life sciences tools industry has benefited from a significant uptick in demand and orders as a result of COVID-19, with some companies recording up to $5 billion dollars in new revenue directly tied to the virus. Of course, pharmaceutical and biotechnology companies are spending billions of dollars to develop treatments and vaccines at unprecedented speeds.

Overall, the second quarter was characterized by results that were weak compared to last year, but not as bad as many investors feared. Just as important, COVID-19 is highly discriminatory by nature and has created an environment of winners and losers. Companies that are experiencing increased demand in the COVID-19 era have benefited significantly, while weakness has clouded investment prospects for those firms whose products or services are negatively impacted. Technology, home improvement, home building, and online retailers were generally strong, while travel and cyclical industries were relatively weak.

Despite the bifurcation across the various sectors of the economy, there has been a persistent trend of gradual improvement across many industries and consensus expectations suggest a continuation of the upward trajectory. As we look forward to the coming months, we will be watching closely for confirmation that the improving trend remains on solid footing and perhaps can even expand to include more cyclical segments of the economy.