July 17, 2020 - Major indices went in different directions this week. The Nasdaq, until recently the leader in the rally, posted a loss, while the Dow Jones and S&P 500 posted gains for the week.
This week was also the start of earnings season. So far, estimates seem to have been revised down far enough for companies to still report better-than-expected numbers. FactSet says that S&P 500 reported earnings and estimates for companies that have yet to report points to a 44% year-over-year decline for the second quarter. As of now, estimates point to a 24.4% decline in the third quarter and a 12.4% decline in the fourth quarter. A return to earnings growth is forecast for the first quarter of 2021, but that comes against a first quarter this year that was down 14.6% from the first quarter of 2019.
As always, forward guidance and other commentary about business conditions is much more interesting than the quarterly beat/miss game. Beginning on Tuesday morning with some of the nation's largest banks, the view of the future, at least as it pertains the next couple of quarters, doesn't seem overly bright.
"Our view of the length and severity of the economic downturn has deteriorated considerably from the assumptions used last quarter," said Charlie Scharf, the CEO of Wells Fargo (WFC).
That may seem like the CEO of a company reporting a bad quarter wanting to blame outside forces, but Citigroup (C) CEO Michael Corbat was just as pessimistic, and his bank topped estimates.
"I don't think anybody should leave any bank earnings call this quarterly simply feeling like the worst is absolutely behind us.. We don't want people leaving the call simply thinking the world is a great place and it's a V-shaped recovery," Corbat said.
JP Morgan's (JPM) Jaime Dimon and David Solomon from Goldman Sachs (GS) were also not optimistic about the economy being on the right track. Solomon said he expects the economic effects to play out over the medium term with a "flattening" of the recovery we've seen so far.
"This is not a normal recession. The recessionary part of this you're going to see down the road.. You will see the effect of this recession. You're just not going to see it right away because of all the stimulus," Dimon said.
So why are bank CEOs, some of whom reported pretty good quarters, so down on the next few quarters?
First, let's look at the second quarter was better-than-expected for some banks. The market was exceptionally volatile in the second quarter. Stocks bottomed in March and were in a strong uptrend for almost the entire second quarter. Other asset classes also saw big gains after dropping sharply to finish the first quarter. This is great for banks that have trading and market-making desks. High trading volumes and high volatility means lots of extra business for those parts of the bank. Also, lots of companies went to the market for new funding in the second quarter. Many struggling companies held secondary stock offerings or went to the bond market for money during the quarter. Those offerings are run and managed by investment banks, which again is great for the financial firms that do that kind of business.
So, where is business bad? In the traditional banking part of the banks. After setting aside tens of billions of dollars for loans they expect to go bad in the first quarter, banks are following that up with tens of billions more dollars even more loans they now expect to go bad.
And it isn't just banks. Netflix (NFLX) said Thursday that it expects to add about 2.5 million subscribers in the third quarter, roughly half of what Wall Street expected.
Meanwhile Delta's CEO, Ed Bastian, was clear about what it causing the slowing in the recovery, saying "Demand growth has largely stalled... It was growing at a pretty nice clip through June.. The virus, unfortunately, was also growing."
Bastian managed to sum up the economic outlook pretty well. Until the virus is under control, the economy will remain throttled back. We've seen this in data, including the JP Morgan Chase consumer spending tracker which has consistently shown that areas with lockdowns and areas without lockdowns haven't differed that much in terms of consumer spending through the crisis.
Consumer spending has held up better than expected. Chase's spending tracker says spending was down about 11% year-over year, which is a remarkably small decline given that unemployment has gone from about 3.7% to more than 11% in that period.
Those spending trends may not hold up much longer though. Expanded unemployment benefits and other economic rescue measures are set to expire later this month. Without some extension of those programs, or some other new program, millions of Americans will see their incomes drop. With states re-imposing lockdown orders and a resurgent coronavirus, it seems incredibly unlikely that tens of millions of jobs will open up in the next two weeks.
Expect to hear a lot about the progress of negotiations in the next two weeks. Also, expect more volatility as that deadline gets closer and negotiations drag on.
Going back to FactSet's earnings data for a minute, The S&P 500 currently has a forward 12-month price-to-earnings ratio of 22.3, which is above both the five and ten-year averages for that metric. Stocks are still priced for a V-shaped recovery that the corona virus is making seem less and less likely. A sudden stop to benefits that millions of consumers are relying on will likely erase much of the economic recovery we've seen so far.
All told this week, the S&P 500 added 1.25%, the Dow Jones gained 2.29% and the Nasdaq lost 1.08%.