Show Transcript
The COVID-19 pandemic accelerated the corporate earnings downturn in the first half of the year, especially for sectors like airlines, hospitality, and energy. But with a potential vaccine on the horizon, the corporate profit outlook may not be all doom and gloom. Anthony Okolie speaks with Damian Fernandes, Portfolio Manager at TD Asset Management.
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- Since the start of a pandemic, corporate earnings have been under pressure and expectations downgraded. Take a look at this next chart. It shows the S&P 500 earnings per share year-over-year percentage growth. Damian, walk us through this chart and explain to us what it shows.
- Sure, Anthony. So this is just earnings growth for the S&P year on year, you know, going back the last few years. I actually like spreading it out these last few years because it shows prospective. You kind of see for the most of 2018, you had these outsized earnings-growth figures, right? That was a result of the Donald Trump tax cuts, pretty buoyant global economy, companies in the US delivering.
And then, of course, you see earnings taper off. It looks like they fall off a cliff. The initial tapering off, the initial drawdown in earnings was a result of trade-induced pain, the trade war with China.
2020, this year, highlighted by red, was actually expected to be positive earnings growth. Before the pandemic, earnings growth should have been actually quite robust. But then, of course, the pandemic came out of left field, and earnings literally fell off a cliff. For example, in Q2, earnings were down over 20%, highlighted by that red bar.
But then what's interesting is that you can see that inflection. Q2 was literally the lowest point of earnings. And Q3 so far, earnings are coming in much better than expectations, to the point where Q4 earnings are just supposed to be down a little under 10%. When you think in the context of we're in a global pandemic, a global recession, earnings down a little over 10% for Q4 is actually quite positive.
I love that last thing at the end because the green bar at the end shows you what's supposed to happen next year where we're supposed to have a return to normal, positive earnings growth.
- OK, so first let's talk a little bit about some of the winners and losers during this current earnings period.
- So the earnings, it is really anomalous earnings recession in the sense that for a lot of companies in the US, earnings have actually been positive. For example, we're using digital tools right now to have this conversation. If you operate in the digital world, whether you are Facebook, Amazon, Microsoft, all of those digital companies, they are having year over year in earnings and cash flows are up versus a lot of other companies too that you might take for granted-- for example, home improvement because we're all quarantined at home. Home improvement is booming.
So the earnings recession has really been concentrated in the companies that have been most affected by the pandemic. Think travel-related companies. Think banks that have been affected by loan losses. So a small little subset has really had earnings disappear, and that's what's led to the drawdown.
But if you believe the pandemic-- and there's some really optimistic news coming out on the vaccine. If you believe that collapse in earnings is temporarily, it sets us up for a really positive backdrop for the following year, for next year, 2021.
- And do you think that this optimism around earnings in 2021 is reflected in the earnings expectations going forward?
- Well, you know what? Normally when you look at earnings estimates, it's always there's an air of optimism around them, right? Analysts are always exuberant. They always have forecast these earnings that are high that they have to then ratchet down as earnings come in.
Interestingly, next year, earnings are supposed to be about 12%. I think that might be on the low end, right? Because when you think about it, because the earnings pain has been so concentrated in a subset of industries, in a vaccine scenario where, if we have a vaccine and life can slowly return back to normal, those companies, those energy companies, those financial companies, they should see actually a pretty robust recovery in earnings.
Whereas the rest of the market was fine this year. I talked about those companies. They'll be fine next year if economic growth continues. You could actually-- look, I don't want to put numbers here because it's hard to-- because so much of it is going to be based on these really difficult things to forecast like the price of energy and what's the level of loan losses? But I actually think that the 12% earnings-estimate number for next year is pretty achievable. In fact, it might be at the low end if we have a massive stimulus package.
- So you're optimistic going forward about earnings expectations?
- Yeah. Look, I'll say tempered optimism is probably the right way to think about this, but the stars are really aligning, right? Given the political-- what's happened in the political space, it doesn't look like there might be any big changes in taxes or significant changes in regulation. We know that there's still going to be stimulus in the pipeline, and likely there could even be some additional fiscal stimulus coming in. And we know that we have a vaccine that's efficacious so that these industries that have felt most of the pain should actually see some semblance of a return to normal.
I think all of those things you know actually set the roadmap for earnings getting back to where they were and prior levels. Think about it this way, right? If earnings estimates for next year are even achievable, they'll be at the same level they were in 2019, 2020. I think that's not far fetched given the strength of the consumer and how much stimulus there is in the system.
- Damian, thank you very much for your insights.
- Always a pleasure, Anthony.
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- Sure, Anthony. So this is just earnings growth for the S&P year on year, you know, going back the last few years. I actually like spreading it out these last few years because it shows prospective. You kind of see for the most of 2018, you had these outsized earnings-growth figures, right? That was a result of the Donald Trump tax cuts, pretty buoyant global economy, companies in the US delivering.
And then, of course, you see earnings taper off. It looks like they fall off a cliff. The initial tapering off, the initial drawdown in earnings was a result of trade-induced pain, the trade war with China.
2020, this year, highlighted by red, was actually expected to be positive earnings growth. Before the pandemic, earnings growth should have been actually quite robust. But then, of course, the pandemic came out of left field, and earnings literally fell off a cliff. For example, in Q2, earnings were down over 20%, highlighted by that red bar.
But then what's interesting is that you can see that inflection. Q2 was literally the lowest point of earnings. And Q3 so far, earnings are coming in much better than expectations, to the point where Q4 earnings are just supposed to be down a little under 10%. When you think in the context of we're in a global pandemic, a global recession, earnings down a little over 10% for Q4 is actually quite positive.
I love that last thing at the end because the green bar at the end shows you what's supposed to happen next year where we're supposed to have a return to normal, positive earnings growth.
- OK, so first let's talk a little bit about some of the winners and losers during this current earnings period.
- So the earnings, it is really anomalous earnings recession in the sense that for a lot of companies in the US, earnings have actually been positive. For example, we're using digital tools right now to have this conversation. If you operate in the digital world, whether you are Facebook, Amazon, Microsoft, all of those digital companies, they are having year over year in earnings and cash flows are up versus a lot of other companies too that you might take for granted-- for example, home improvement because we're all quarantined at home. Home improvement is booming.
So the earnings recession has really been concentrated in the companies that have been most affected by the pandemic. Think travel-related companies. Think banks that have been affected by loan losses. So a small little subset has really had earnings disappear, and that's what's led to the drawdown.
But if you believe the pandemic-- and there's some really optimistic news coming out on the vaccine. If you believe that collapse in earnings is temporarily, it sets us up for a really positive backdrop for the following year, for next year, 2021.
- And do you think that this optimism around earnings in 2021 is reflected in the earnings expectations going forward?
- Well, you know what? Normally when you look at earnings estimates, it's always there's an air of optimism around them, right? Analysts are always exuberant. They always have forecast these earnings that are high that they have to then ratchet down as earnings come in.
Interestingly, next year, earnings are supposed to be about 12%. I think that might be on the low end, right? Because when you think about it, because the earnings pain has been so concentrated in a subset of industries, in a vaccine scenario where, if we have a vaccine and life can slowly return back to normal, those companies, those energy companies, those financial companies, they should see actually a pretty robust recovery in earnings.
Whereas the rest of the market was fine this year. I talked about those companies. They'll be fine next year if economic growth continues. You could actually-- look, I don't want to put numbers here because it's hard to-- because so much of it is going to be based on these really difficult things to forecast like the price of energy and what's the level of loan losses? But I actually think that the 12% earnings-estimate number for next year is pretty achievable. In fact, it might be at the low end if we have a massive stimulus package.
- So you're optimistic going forward about earnings expectations?
- Yeah. Look, I'll say tempered optimism is probably the right way to think about this, but the stars are really aligning, right? Given the political-- what's happened in the political space, it doesn't look like there might be any big changes in taxes or significant changes in regulation. We know that there's still going to be stimulus in the pipeline, and likely there could even be some additional fiscal stimulus coming in. And we know that we have a vaccine that's efficacious so that these industries that have felt most of the pain should actually see some semblance of a return to normal.
I think all of those things you know actually set the roadmap for earnings getting back to where they were and prior levels. Think about it this way, right? If earnings estimates for next year are even achievable, they'll be at the same level they were in 2019, 2020. I think that's not far fetched given the strength of the consumer and how much stimulus there is in the system.
- Damian, thank you very much for your insights.
- Always a pleasure, Anthony.
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