The Q2 earnings season begins in earnest next with the big banks lined up to report. This week, we highlight a few observations that fall into three buckets: the good that the economy is/was recovering, the bad that cases are rising and we are in a recession, and the hope that we will get a better picture of how the economy is doing as we head into the Q2 earnings season.

A sample of companies reporting next week (Source: Interactive Investor)

The Good: A Tentative Economic Recovery is Underway

The key theme we have picked up in the past few weeks is that, since hitting the bottom in March and April, most sectors that were highly negatively impacted have been showing some signs of slow recovery. We have seen more positive tones in management teams in earnings calls in the past few weeks, reflecting positivity in sentiment. IHS Markit (NYSE:INFO) noted that there are signs that business and consumer sentiment is turning positive. Just last month, the consumer sentiment had its second monthly gain over the April lows. We would expect this slightly more positivity to be reflected in the Q2 earnings reports.

Source: University of Michigan

Several company CEOs have noted recovery trends. Last week, Macy’s (M) CEO Jeff Gennette reported that sales are improving on a weekly basis, while Pebblebrook Hotel Trust (PEB) CEO Jon Bortz stated that business travel is returning slowly. Other companies had this to say:

US manufacturers have reported a marked turnaround in business conditions through the second quarter, with collapsing production and demand in April at the height of the COVID-19 lockdown turning rapidly to stabilisation by June. – IHS Markit (INFO) Chief Business Economist Chris Williamson

To date, we have experienced a week-over-week improvement in our business since hitting the bottom in mid-April. As we enter fiscal 2021, there are signs of tentative economic recovery underway – FedEx (FDX) EVP, Chief Marketing and Communications Officer Brie Carere

We are encouraged by the gradual restart of economic activity in the U.S. and globally, which support stronger macro trends of higher scrap demand, supply flows, and prices – Schnitzer Steel Industries (SCHN) CEO Tamara Lundgren

We did see a more rapid return in May and June than we initially anticipated, with May’s volume nearly doubling versus April and June approaching levels we saw earlier in the year – RTI Surgical Holdings (RTIX) CEO Camille Farhat

..overall, the trend is definitely heading in the right direction – Deutsche Post (DPW) CEO Frank Appel

If the past few weeks are anything to go by, we should expect to see more positive signs of economic improvement in the Q2 reports that should be reflected in such areas as rising load factors and bookings in airlines, more store traffic as more stores open up, and in improving manufacturing levels.

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Source: The Daily Shot

The Bad: The Rising Viral Cases are Creating Worry

The real worry though is that viral cases are rising in the US and in some specific other countries like Brazil. It feels like a second wave. Rising cases usually precede rising deaths in a few weeks. The reopening may stall, and people may have to go back into lockdowns. Executives are really worried about this:

Again, I can’t tell you much about 2021 because I just don’t have a feel for what’s happening as – nor does anyone else. I mean, the virus is seemingly coming back in a lot of states, openings are slowing down. People are delaying their openings. Microsoft shut-in retail stores. Just a lot of things that are going on here that make it extremely difficult to answer that question – FedEx (FDX) Alan Graf

While the PMI currently points to a strong v-shaped recovery, concerns have risen that momentum could be lost if rising numbers of virus infections lead to renewed restrictions and cause demand to weaken again – IHS Markit (INFO) Chief Business Economist Chris Williamson

So I think what you’re going to seeing barring some major lockdown is that you’re going to have more waves of this virus, that’s for sure.” – Korn Ferry (KFY) CEO Gary Burnison

As these worries rise, consumers seem to still be stocking their pantries in readiness for anything that can happen:

“While there certainly was a stock up in March, and you can see that in the data, consumers are clearly still buying and eating through the stock that they have on hand…at least in North America, we believe that the majority of the product that we’ve moved to consumers has been consumed. We do believe that consumers are keeping slightly higher levels of inventory in their pantry, but we do expect that to continue.” – General Mills (GIS) President Jon Nudi

There is also the challenge that the economic recovery that was seen in May/June also seems to be stalling a little in the past few weeks as viral cases rise.

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Source: The Daily Shot

The Hope: Better Visibility on Emerging Trends

Despite the causes for concerns, there are some trends that we have seen in the past few weeks whose continuation we would expect to see in Q2 reports:

Digital sales have risen: Digital sales are rising as companies continue to shift online, and with them come rising costs and diluted margins since online setups take a while to be profitable.

I believe that e-commerce change is structural. We have seen a huge uptick in the categories that people are willing to purchase online, certainly moved into a higher value. We saw this trend obviously pre-COVID, but it has accelerated when you think about things like furniture, large packages, high-value electronics…we saw a huge change in who is buying online, over 65 finally moved to online – FedEx (FDX) EVP, Chief Marketing and Communications Officer Brie Carere

What will happen to the office? There has been a lot of debate on how the future office will look like. We should see a bit more clarity on what companies are thinking in terms of how the future of the office looks like in the Q2 reports. Steelcase (SCS) CEO Jim Keane reminded us though that the office is not dead but will change significantly:

We believe as we emerge from this crisis, working from home will be embraced by more companies as part of a holistic approach to more effective work…but the office is far from dead. In fact, we believe customers and their employees will expect more from the office as we look to the future, and that’s where our conversations are centered. Meeting spaces will need to more fully support remote participants. When employees need to really focus on individual work, spaces must provide privacy and separation without compromise – Steelcase (SCS) CEO Jim Keane

The move to the cloud is just starting: We noted a few weeks ago that several management teams have started having conversations on moving to the cloud. Micron Technology (MU) CEO Sanjay Mehrotra reminded us that we are only in the early innings of the move to the cloud:

When you look at long-term trends, I mean long term cloud is still actually in early innings and long-term trends for cloud are strong because AI as well as 5G, 5G driving more intelligent devices at the edge, growing more data opportunities, it’s really the virtuous cycle between cloud and intelligent devices at the edge

Housing demand is high, but supply is low: We would love to see a bit more clarity on how the market is coping with this short-term low supply vs high demand and how this is reflected in housing prices. The Case-Shiller Home Purchases Index is indicating rising home prices.

While we’ve seen a strong v-shaped recovery in homebuyer demand, mortgage applications and pending sales, lack of supply remains the biggest impediment to home sales growth…Buyers can only buy what’s for sale and sellers have been a bit slower to come back to the market. Though we have seen strong weekly improvements in new listings coming on the market, there aren’t enough new listings to satisfy demand, creating more competition and pushing prices higher – Redfin (RDFN) lead economist Taylor Marr

Over 90% of our agents are telling us that their markets across the U.S. have a shortage of listings, and over 80% are saying there is pent-up demand. – Coldwell Banker CEO Ryan Gorman

Conclusion

In sum, we see some things to be positive about, some to be to make us worried, and some to make us hopeful. We reiterate our cautiously optimistic tone as Q2 reports start to flow in. Let the earnings season begin!

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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