By Karen Langley
Big U.S. companies have trounced expectations this earnings
season, potentially laying the foundation for the next leg of the
stock market's rally as investors look beyond the election.
With most of the companies in the S&P 500 reporting,
analysts are projecting third-quarter profits fell 7.5% from a year
earlier, according to FactSet. That is a sharp improvement from the
21% decline they forecast at the end of September.
The brightening earnings picture shows the speed at which many
companies are recovering from the coronavirus-induced downturn,
even as the pandemic continues to weigh on the broader economy.
United Parcel Service Inc., Citigroup Inc. and Taco Bell parent
Yum! Brands Inc. are among those that have reported results that
handily beat projections.
"The market overall is getting more comfortable with the
resilience of corporate America," said Anik Sen, global head of
equities at PineBridge Investments, which manages about $111.7
billion. "Not just because we have fiscal stimulus, not just
because we have the Fed standing by, but the resilience of
corporate America in terms of expectations."
The much-stronger-than-expected results, according to bullish
investors, are evidence of a V-shaped recovery in the economy and
could propel stocks out of a narrow trading range to new highs. The
S&P 500 is up 8.6% this year and 2% below the record set in
Last month investors largely appeared to shrug off the improving
earnings: As corporate results rolled in throughout October -- a
month punctuated by campaign developments and worrying coronavirus
news -- the S&P 500 fell 2.8%. Shares of companies that
reported stronger-than-expected profits for the third quarter have
inched up only 0.4% on average from two days before their reports
to two days after, compared with the five-year average of 0.9%,
according to FactSet.
Then, as election results suggested that Congress might be
divided -- and less likely to approve major policy changes -- the
market shook off its lethargy. The broad U.S. stock index surged
7.3% last week in its best weekly performance since April.
The easing political concerns could make room for renewed focus
on fundamentals and how companies are navigating a business
environment reshaped by a still-spreading virus. Although investors
anticipated an earnings rebound, the extent to which profits
surpassed estimates could inject new confidence.
Corporate earnings are the biggest driver of stocks over the
long term, though in recent years, stock prices have climbed faster
than profits. In the week ahead, investors will look to reports
from McDonald's Corp., Walt Disney Co. and networking-equipment
company Cisco Systems Inc. for clues about the recovery.
Analysts expect earnings will decline 11% year over year in the
fourth quarter before beginning to climb again in the first quarter
In recent weeks, PineBridge Investments has trimmed positions in
big tech companies and bought shares in other sectors, including
financials and industrials, on expectations that a wider array of
stocks will begin to contribute to the market's performance,
according to Mr. Sen.
The S&P 500's rally this year has been driven by advances in
megacap tech stocks, such as Apple Inc., which is up 62% for the
year, and Amazon.com Inc., which has rallied 79%. Meanwhile, more
than half of the companies in the index are in negative territory
for the year.
The earnings picture brightened in part because of results from
those companies and their peers Facebook Inc., Microsoft Corp. and
Google's parent, Alphabet Inc. But the earnings beats are
widespread, with 86% of reporting S&P 500 companies having
exceeded estimates. Analysts have lifted third-quarter expectations
for all 11 S&P 500 sectors.
Among the groups to see major shifts, the communications
services group, which includes Facebook and Alphabet, is projected
to record a 2.3% increase in profits from a year earlier, compared
with expectations at the end of September for a drop of 21%. Buoyed
by stay-at-home trends, both companies reported strong earnings
The consumer staples group is expected to see an earnings
increase of 4%, a reversal from an anticipated decline of 4.9%.
Retailers have benefited as shoppers boosted their spending over
the summer. On a Costco Wholesale Corp. earnings call in September,
Chief Financial Officer Richard Galanti said the strength in sales
of big-ticket items had been a little surprising.
"In some instances, we had tried to cut back a few orders back
in March and April for seasonal summer goods like patio furniture,"
he said. "Very quickly, we were having to scramble for more of
On the other hand, estimates have improved only slightly for the
hard-hit energy sector, which has been beset by low oil prices and
a dramatic slump in demand. The sector is projected to record a
quarterly loss, just slightly smaller than the one estimated a few
The rebound in corporate profits coincides with a record pace of
growth in the economy in the third quarter. Data suggest that the
U.S. has recovered about two-thirds of the ground it lost earlier
in the coronavirus pandemic and that the improvement has continued
in the fourth quarter, though at a slower pace.
"The earnings to some extent have been confirmation of some of
the trends that were already in place in this recovery, as things
sort of bottomed out and then the economy started to reopen and
sentiment started to pick up," said Holly MacDonald, chief
investment officer at Bessemer Trust.
Despite those reasons for optimism, analysts caution that it
might be difficult for stocks to continue powering higher. That is
because the market is looking increasingly pricey. The S&P 500
traded Thursday at 21.80 times its projected earnings over the next
12 months, above a five-year average of 17.56, according to
FactSet. Valuations are higher among the tech darlings: Apple, for
example, was trading at 29.90 times expected earnings, above a
five-year average of 16.05.
The price tags are giving pause to some investors who say
companies that don't keep up their rapid growth could find their
shares in a precarious position.
"The earnings results right now are really, really good," said
George Cipolloni III, portfolio manager at Penn Mutual Asset
Management. "If you look at...valuations, it sets that kind of high
bar where earnings have to continue to be good."
Write to Karen Langley at email@example.com
(END) Dow Jones Newswires
November 08, 2020 05:44 ET (10:44 GMT)
Copyright (c) 2020 Dow Jones & Company, Inc.
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