Heading into second quarter earnings season, it wasn’t a question of if it would be bad – we knew the Y/Y earnings collapse of more than -40% would be the worst since the financial crisis – but what hints management teams would give on the outlook to at least give the impression that things are getting better.
And that’s precisely what is taking place: according to BofA, not only has there been a prevalence of top and bottom-line beats, but when it comes to the future, management teams have never been more optimistic… literally.
Here are the facts: Through this weekend, 127 S&P 500 companies (40% of EPS) have reported, with another 37% set to report this week.
Results are tracking 2% above analysts’ expectations at the start of July, and 2Q EPS is now $23.71 (-43% y/y) after bottoming at $23. More notably, 61% of companies have beaten on EPS and sales, well above the 40% post-Week-2 average. Health Care and Tech lead in beats, but Tech is lower since earnings season began.
Upward revisions last week were driven by better-than expected results in Health Care and Tech. Overall, 77% of companies have beaten on EPS, 73% have beaten on sales and 61% have beaten on both – well above average, where typically 40% have positively surprised on both metrics following Week 2.
With earnings generally better than “macheted” expectations, sales are also beating by a modest 1%. ACcording to BofA, bottom-up sales expectations have risen across most sectors by more than 1% since the start of July, with analysts expecting sales -10% y/y (with declines across all sectors except Health Care and Tech). Meanwhile, FX was a ~1ppt headwind to YoY growth, similar to last quarter. Excluding FX/oil impacts, constant-currency sales growth for the S&P 500 ex. Fins. & Energy is expected to be -6% % YoY 5), vs. +3% YoY in 1Q.
That’s the good news. Now the not so good news:
So far, margins are coming in slightly (~20-30bp) ahead of expectations earlier this month (true for the Tech sector as well), but still slated to decline substantially both sequentially and y/y. Analysts expect S&P 500 non-Financial net margins to collapse to 7.5% (8.5% ex-Energy), 220bp lower than last quarter and 350bp lower than a year ago. The biggest sequential margin declines are expected in Energy (-10ppt), Discretionary and Industrials (both -5ppt). Discretionary is slated to be the biggest contributor to the aggregate decline in S&P margins, followed by Industrials and Tech (where for the latter, 2Q margins are expected to fall ~1.5ppt sequentially).
While margins are slated to collapse, the offset may be job cuts (not that that’s a positive): profit margins, one of the most important factors on watch this quarter, are tracking a hair above expectations, but are still slated to collapse 350bp y/y, led by Energy and Retail, with commentary around employment indicates potential for more cuts: Paychex: “…if [a client] had 20 or 30 employees, they might have 15 or 20 now”; others are “removing layers of management”, offering “voluntary separations” etc.
Weak current conditions…but lots of optimism
Yet despite the overall plunge in top and bottom line, and the collapse in margins, management teams are taking it in stride. In fact, even though so far the tone on earnings calls echoes the broader economic weakness – with the ratio of mentions of “better” or “stronger” vs. “worse” or “weaker” in transcripts is tracking the lowest since 2Q09 – optimism is soaring. Indeed, as the chart below shows, management has never been more optimistic about the future, suggestive of a the expected improvement in profits in subsequent quarters – mentions of optimism on earnings calls are so far tracking at the highest levels in BofA data history (since ’03).
While indicative of a possible inflection point, this soaring optimism may simply mean that managements are overly hopeful of a sharp recovery, and should this record optimism proves wrong the resulting collapse in sentiment will be unlike anything seen before, sending another far more powerful negative shockwave across corporate America.
Tied to this optimism – whether justified or not – BofA concludes that the buyback and dividend suspensions and cuts is likely largely behind us: “Announced buyback programs have dropped off significantly within the S&P 500, with aggregate announced buybacks in 2Q20 the lowest since 4Q17 (Chart 17) and announcements in July so far nearly non-existent.”
But buyback suspensions have also slowed down significantly since last earnings season, with barely any announcements in June/July Overall just under 100 S&P 500 companies suspended buybacks since the start of March, dominated by Consumer Discretionary and Financials (Chart 16).
BofA also thinks S&P 500 dividend cuts are largely behind us, where 64 companies in the index have cut dividends since March, 40% of which are in Consumer Discretionary, but only of those cuts occurred in June/July.